How the Household Settlement Uncorked a Law Enforcement Bottleneck by Sally Peacock | sspruce | July 14, 2011


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How the Household Settlement Uncorked a Law Enforcement Bottleneck by Sally Peacock

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How the Household Settlement Uncorked a Law Enforcement Bottleneck


By Sally Peacock




On October 11, 2002, twenty State Attorneys General announced a record-breaking settlement with Household International for its alleged predatory lending practices in the subprime mortgage lending market.[1] This settlement has been heralded by the press, the State Attorneys General and bank regulators as a “blueprint for national standards” in the mortgage lending industry. [2] The Household settlement, however, can do more than provide guidelines to lenders. It can act as a template for future multi-state, multi-agency Attorney General action against both predatory lenders and other law violators.


Part I defines the problem of predatory lending, including the business practices used by predatory lenders and the effect of those practices on both individual borrowers and the economy. Part II explains the three solutions that have been used in the past to stop predatory lending: federal legislation and enforcement, state legislation, and private lawsuits. This section concludes that these forms of law enforcement have failed to curb predatory lending sufficiently. Part III describes the formation of the unique multi-state team that investigated Household and examine the terms of the settlement, highlighting both its strengths and weaknesses. Part IV assesses the settlement’s potential as a blueprint for future multi-state investigations.


Part I: The Problem


A. Defining Predatory Lending


Nationwide there exist three markets for mortgages: prime, subprime and predatory. [3] In the prime market, borrowers with strong credit histories receive mortgages with “interest rates below the market-clearing rate” and often no prepayment penalties. [4] Competition among lenders and regulation by both federal and state governments lead to overall similarity between loan terms. [5] The borrowers in this market tend to have “greater familiarity with complex financial transactions” than those in the subprime market. [6]


The subprime mortgage market serves borrowers who lack the credit history required for a prime mortgage. [7] Legitimate subprime lending thus “provides an important service, enabling such borrowers to buy new homes, improve their homes, or access the equity in their homes for other purposes.” [8] Subprime lenders compensate for these mortgages’ comparatively higher risk by charging higher interest rates than their prime counterparts.


Professor Kurt Eggert states that the regulation of the subprime market is “rarely enough . . . to protect borrowers in an era when many homeowners are borrowing hundreds of thousands of dollars at a time.” [9] Not surprisingly, nearly all predatory lending takes place in the subprime market. [10] Subprime borrowers are often less sophisticated, and many live in low-income neighborhoods which are served only by predatory lenders. [11]


Predatory lending denotes the use of at least one of a host of business practices to gain an unfair advantage over a borrower. [12] While HUD has asserted that defining predatory lending is a “problematic task,” [13] Kathleen Engel and Patricia McCoy argue that such practices fall into one of five categories: “loans structured to result in seriously disproportionate net harm to borrowers, harmful rent seeking, loans involving fraud or deceptive practices, other forms of lack of transparency in loans that are not actionable as fraud, and loans that require borrowers to waive meaningful redress.” [14] Specific practices include racial targeting in advertising, [15] steering of borrowers to high-cost lenders, loan payments which decrease a borrower’s home equity with each payment (“equity stripping”), mortgages structured to result in foreclosure (“asset-based loans”), fraud on borrowers and secondary market buyers using falsified loan applications, high points, balloon payments, negative amortization, padded or duplicative closing costs and fees, insurance packing, excessive prepayment penalties, mandatory arbitration clauses, loan flipping/refinancing, loans in excess of 100% of loan-to-value ration of underlying collateral, and abusive collection practices.[16]


As explained in Part II-C, infra, the securitization of mortgages plays an important role in predatory lending. During the 1980s, the mortgage industry witnessed a steep increase in securitization. Professor Kurt Eggert explains that

    securitization is the process of aggregating a large number of notes secured by deeds of trust in what is called a mortgage pool, and then selling security interests in that pool of mortgages. Through securitization, the source of capital for mortgage funding has been transferred from the savings industry, which used deposits to fund loans, to the capital markets and the portfolios of institutional investors. [17]

As a result, over sixty percent of mortgages are originated with mortgage brokers, rather than traditional banks. [18] A combination of federal and state regulations govern these mortgage brokers, leading to variation from state to state.


B. The Impact of Predatory Lending upon its Victims


Predatory lending has devastating effects on its victims. These borrowers tend to be unsophisticated about their loan options, and are predominantly low income and working class adults. [19] Frequently, predatory lenders target minority and/or elderly individuals.


In gathering complaints about Household’s lending practices, investigators found that borrowers “were varied, and included low income borrowers in the working class, and even middle income suburbanites,” although the demographic data Household has filed with the federal government shows that its loans were concentrated in minority communities. [20] In the southwest, complaints about Household came mostly from Hispanic borrowers. The State Attorney General of Arizona [21] fielded numerous complaints mainly from Hispanics unable to read the English loan documents Household sent them. [22] Understanding why predatory lending so affects minority populations is thus crucial to analyzing the Household settlement.


Much of the scholarly literature on the racial implications of predatory lending has focused on Afro-Americans. Predatory lenders target Afro-American communities for a variety of reasons. First, Afro-Americans often have lower credit ratings than whites, which places them in the subprime market for mortgages. [23] For instance, in 1989 45% of Afro-American households had checking accounts, while nearly 80% other households did.[24] Second, unemployment rates are higher in Afro-American communities, resulting in a lack wealth in either inheritance or savings.[25] A borrower is thus unlikely to find assistance in the form of loans or guarantors within her community, leading her to predatory lenders for assistance. [26]


Finally, due to redlining, predatory lenders often stand as Afro-Americans’ only choice for a loan. [27] While Congress has enacted laws to address redlining, evidence indicates that it continues to be a common practice. [28] According to William J. Brennan, Jr., director of the Atlanta Legal Aid Society’s housing and consumer division, predatory lenders often fill the “credit-vacuum” created by redlining. [29] Once a prime lender has redlined a neighborhood, “high-cost finance companies target those same communities with overpriced loans, knowing that the residents are a captive market with no access to reasonably-priced credit.” [30] This practice is known as reverse redlining. Often the same institution both redlines and reverse redlines a neighborhood, creating a market for predatory lending through its own discriminatory practices.[31]

23The Elderly24

Along with minorities, predatory lenders also target the elderly. Older people have characteristics that make them especially attractive to such lenders. First, older people tend to be “house rich but cash poor,” [32] because they have paid off their original mortgages and subsist on a small, fixed income. Seniors are often faced with medical or home improvement expenses which cannot be paid by this limited and fixed monthly income. In addition, many elderly people have little experience with complex financial transactions, suffer from medical infirmities, and live in relative isolation. The combination of all these characteristics make the elderly particularly susceptible to predatory lending schemes, and particularly attractive to predatory lenders. [33] Indeed, housing advocates report that predatory lenders engage in a practice of searching the Registrar of Deeds to find homes in low-income neighborhoods without mortgages, searching other public records to find homeowners’ ages, and touring those neighborhoods to find such homes in need of repair.


“Reverse mortgage loans…permit homeowners age sixty-two and older to turn their heretofore nonliquid house into an income-producing asset.” [34] Under most reverse mortgages, the senior does not have to repay the loan until she leaves her home or dies, without risk of foreclosure. [35] However, elders continue to be at risk for “asset-based loans,” which aim to foreclose on the borrower. [36]


In his 1998 testimony before Congress, William Brennan revealed the scope of such abuse by telling the story of a seventy-year-old widow who had owned her house for twenty years took out a $54,300 loan with 12.85% interest. Her monthly payments total nearly $600, and at the age of 83 she will be liable for a balloon payment of $47,599. She also paid a $700 fee to her mortgage broker for helping her find this loan. [37] Brennan’s story illustrates the risk of asset-based loans which aim to foreclose on the borrower so that the lender can purchase the foreclosed home at auction. [38]


Reverse mortgages are not an inherently damaging financial instrument. The difference between beneficial and damaging reverse mortgages is suitability. [39] A reverse mortgage suitable to one senior may lead to the bankruptcy of another. Although a lender should recommend only those loans suitable for the particular customer, seniors like the aforementioned widow can fall prey to unsuitable reverse mortgages.


The loss imposed by predatory lenders is uniquely detrimental to its victims. As one advocate explains,

    homeownership represents the best possible opportunity for families to build wealth and economic security and take their first steps into the middle class. Accumulating equity in their homes is the primary way most families earn the wealth to send children to college, pay for emergencies and pass wealth on to future generations, as well as develop a real stake in society. [40]

Thus just as the working poor achieves the goal of homeownership, the aforementioned business practices take it away. Predatory lending both displays and exacerbates society’s inequality, by bankrupting and foreclosing on its victims.[41]


C. The Economic Costs of Predatory Lending


Predatory lending imposes enormous costs upon society. The Coalition for Responsible Lending, [42] a North Carolina organization, estimates that nationally, borrowers lose $9.1 billion per year to predatory lenders. [43] Of this figure, Responsible Lending attributes $1.8 million to exorbitant fees built into predatory loans, $2.3 billion to prepayment penalties, $2.1 billion to credit finance insurance, and $2.9 billion to rate-risk disparities. Because predatory lenders target low income minority and elderly borrowers, foreclosures concentrate in the minority neighborhoods. [44] A foreclosure effects more than the holder of the mortgage. It can devastate a family, especially because the home is often “the family’s most valuable asset.” [45] A foreclosed home often remains uninhabited for a period, resulting in a deterioration of surrounding property values. [46] Crime rates are higher in uninhabited areas, imposing added costs of law enforcement. [47] This syndrome can eventually lead to the loss of neighborhood cohesiveness and added crime, harming an entire community. [48] As Chicago mayor Richard Daley explains,

    We are seeing a pattern in the city and in the suburbs . . . It's the same story: A family has suddenly abandoned their home. In many cases, it is elderly people who have lived there for many years . . . Once abandoned, these homes have been taken over by gangs and drug people, and they become breeding places for crime. [49]

In addition to injuring its victims, homelessness imposes welfare and public housing costs on society.


Part II: The Solutions of the Past


Both legislators and law enforcement officials have tried to address predatory lending. While the federal government has used both ex ante legislation and ex post law enforcement, state governments have largely been stymied by the complex and partially preemptive regulatory framework that governs lending institutions. Finally, the victims of predatory lenders have tried to use litigation to redress their injuries. Yet none of these solutions has proven sufficient. One group estimates that the city of Albuquerque witnessed a 223% increase in mortgage foreclosures between 1996 and 2000. [50] This phenomenon is likely linked to predatory lending, since subprime lender foreclosures increased 640% over the same time period. [51] The solutions of the past thus affirm the need to use the Household settlement as a blueprint.


A. Federal Legislation and Enforcement


Enacted by Congress in 1983, the Alternative Mortgage Transaction Parity Act (“AMPTA”) [52] is administered by the Office of Thrift Supervision (“OTS”). The stated purpose of AMPTA is to

    eliminate the discriminatory impact that those regulations [adopted by the Comptroller of the Currency, the National Credit Union Administration and the OTS] have upon nonfederally chartered housing creditors and provide them with parity with federally chartered institutions by authorizing all housing creditors to make, purchase, and enforce alternative mortgage transactions so long as the transactions are in conformity with the regulations issued by the Federal agencies. [53]

AMTPA “was created to provide a level playing field for all types of lenders, so that a state could not discriminate against any one type of lender in light of the high inflationary environment.” [54] If a housing creditor qualifies for AMTPA, it must follow federal regulations designated by OTS.


AMTPA has “pre-empted state prohibitions” [55] on predatory lending practices such as balloon payments, negative amortizing loans and adjustable rate mortgages, “notwithstanding any State constitution, law or regulation.” [56] AMTPA provides borrowers with new loan opportunities, but it also “fuel[s] a significant increase in predatory lending practices,” since it provides predatory lenders with a federal preemption defense against claims based on state lending laws.[57]


For many years, housing advocates, the AARP, NAACP and State Attorneys General lobbied the OTS to amend its regulations to restore the states’ ability to regulate these lenders. [58] Finally, in April 2002 the agency announced a proposed rulemaking which would limit the applicability of the AMTPA by “no longer identify[ing] its regulations on prepayment and late charges for housing creditors.” [59] OTS noted that “[c]onsumer groups and states generally urged OTS to limit the applicability of the Parity Act [AMPTA] regulations to enable the states to better regulate non-depository state housing creditors.” [60] On September 26, 2002 (only five days after the FTC announced its settlement with First Associates, discussed infra) OTS promulgated this final rule, which now allows the states to regulate prepayments and late charges for housing creditors.[61]


While the OTS has rulemaking power under AMPTA, the Federal Trade Commission (“FTC”) is the primary federal prosecutor against predatory lending. In addition to the federal Unfair and Deceptive Acts and Practices Act (“UDAP”), [62] the FTC has enforcement authority under the Fair Housing Act (“FHA”), [63] the Truth in Lending Act (“TILA”), [64] and the Real Estate Settlement Procedures Act (“RESPA”). [65] Like the OTS, however, the FTC has largely failed to focus its energies on predatory lending. Engel and McCoy explain that “shifting political winds, and constraints on the FTC’s enforcement resources make private relief under the Federal Trade Commission Act highly unlikely for the vast majority of victimized borrowers.” [66]


The FTC has negotiated settlements with predatory lenders in the past, [67] but most have been for relatively small sums of money. For example, the FTC charged Fleet Finance with violations of UDAP and TILA, [68] settling the case for $1.3 million. [69] Divided among over 30,000 Fleet borrowers, the average victim – many of whom had lost their homes – received only $43.30. [70] In September 2002, the FTC settled with Associates First Capital Corporation, [71] for its largest monetary victory in a consumer protection case. [72] The agency charged First Associates violations of the federal UDAP, TILA, the Equal Credit Opportunity Act (“ECOA”), [73] and the Fair Credit Reporting Act (“FCRA”).[74/75] The agency alleged that First Associates engaged in “loan packing,” by inducing borrowers to purchase optional credit insurance products. [76]


Under the settlement, First Associates will pay $215 million, which the agency will distribute to members of class action filed and certified by a California court. [77] The class consists of borrowers who purchased single premium credit insurance in connection with a real estate-secured or personal loan from First Associates between December 1, 1995 and November 30, 2000. [78]


The settlement also imposes reporting and record keeping requirements on First Associates. The lender must provide the FTC with an annual written report on its sales and marketing of credit insurance and “the progress and status of any and all steps taken to enhance and improve those practices.” [79] The settlement requires that the lender “maintain documents approved for use, and exercise its best efforts to maintain communications from supervisory personnel, relevant to the sale and marketing of real-estate secured and personal loans, credit insurance, and other add-on products.” [80]


Housing advocates have criticized the First Associates settlement. Matthew Lee, executive director of Fair Finance Watch, explained that “the lack of any reforms to CitiFinancial’s [First Associates] current and future practices is a massive flaw in this settlement.” [81] The reporting and record keeping requirements imposed by the settlement fail to guarantee any change in First Associates’ practice of bundling unwanted and unnecessary insurance into mortgage-backed loans. Instead, they shift the onus to the FTC to perform more stringent monitoring of the lender’s practices.


Advocates have been equally critical of the settlement’s monetary relief. Under it most borrowers will receive about $1,000 to cover approximately 60% of their losses. [82] But Lisa Donner, director of the financial justice center for the Association of Community Organizations for Reform Now (“ACORN”), a grassroots organization dedicated to stopping predatory lending, said the previously reported $200 million settlement was "very low compared to the damage that was done." [83] Donner claimed that First Associates’ practices in fact cost class member “thousands or tens of thousands of dollars each.” [84]


The First Associates settlement could be the FTC’s trial run, rather than its “blueprint.” [85] Nevertheless, this “record-setting” agreement provided for less than half the monetary relief of the Household settlement. Combined with the agency’s history of enforcement, First Associates indicates that injured borrowers cannot look with confidence to the federal government to stop predatory lending.


B. State Legislation


In July 1999, North Carolina was the first state to enact a statute specifically prohibiting predatory lending practices. [86] Predatory lending had thrived in the United States since the securitization of mortgage lending in the late 1970s. Two decades would seem to be an unacceptable delay, even by legislative standards. Federalism explains the holdup. The states “have been hamstrung by DIDMCA and AMTPA,” [87] discussed in Part IIA, supra, which preempt state regulation of most mortgage lending. [88]


The 1999 North Carolina law was drafted by Roy Cooper, who was then a North Carolina State Senator (and is now State Attorney General of North Carolina). [89] The Act “represents a compromise between the consumer advocacy interests, banking interests, and the Attorney General's office.” [90] Many housing advocates have praised the Act as “a critical step in encouraging more responsible lending practices [because] it addresses several gaps in the federal law,” [91] while the banking community – after some dispute – supported the bill.


Other legislatures have followed North Carolina’s example. California passed a state predatory lending law in July 2002. Just months later, the Los Angeles City Council preliminarily approved an ordinance that would provide even more protection to borrowers. [92] Georgia has amended its Fair Lending Act (“GAFLA”) to prohibit abusive home loan practices. [93] The New York state legislature passed a predatory lending bill in October 2002 which “follows much the same footprints as legislation passed … by North Carolina.” [94] County Supervisors in Pima County, Arizona plan to “explore the possibility of enacting new laws aimed at curbing predatory lending practices that target the elderly, the poor and Hispanics,” [95] and the Detroit City Council announced hearings on two proposed predatory lending ordinances in November 2002.[96]


The strength of mortgage lending and banking institutions’ political ties creates an uphill battle for housing advocates in the state legislatures. In October 2002, New York Mayor Michael Bloomberg vetoed a predatory lending bill passed by the New York City Council that “would bar the city from doing business with financial institutions that engage in practices or have ties with companies that exploit low-income borrowers.” [97] The Mayor’s action was attributed to the political power of financial institutions. Citigroup (owner of First Associates), J.P. Morgan Chase & Co., the Bond Market Association and the New York City Chamber of Commerce all opposed the bill, arguing “it would impose costly obligations to make sure neither lenders nor their partners were engaged in such practices.” [98] The City Council overrode the Mayor’s veto in November. [99] However, this incident serves as a small example of the obstacles to legislating against predatory lending. Forging political compromises between housing advocates and lenders is a difficult task. Unlike an injunction, legislation is susceptible to changing political tides.


C. Private Suits


Subprime lenders provide important funding to borrowers who might not otherwise be able to purchase a home. Some lenders argue that borrowers are at fault for their impulsive borrowing, and hence should be forced to speak for themselves through the private bar. Indeed, borrowers can file suit for lenders’ violations of unconscionability and fraud, along with a spate of federal statutes. But due to the considerable obstacles plaintiffs face, the private bar is an unrealistic solution to predatory lending.

60Mandatory Arbitration Clauses61

A borrower’s first obstacle is often the mandatory arbitration clause buried in the lending contract. Such clauses have two common effects: limiting the procedural rights of the victim during arbitration, and determining the fee structure arising out of the proceeding. [100] Courts will enforce a mandatory arbitration clause even if its terms are ambiguous. In Green Tree Financial Corp.-Alabama v. Randolph, 531 U.S. 79 (2000), the Supreme Court overturned the Eleventh Circuit’s invalidation of a mandatory arbitration clause which was silent as to fees and procedures. The Eleventh Circuit had reasoned that such an ambiguous clause risked the plaintiff-borrower’s statutory rights under TILA since she could face steep arbitration costs. The Supreme Court held that where “a party [such as the plaintiff] seeks to invalidate an arbitration agreement on the ground that arbitration would be prohibitively expensive, that party bears the burden of showing the likelihood of incurring such costs.” [101] While this decision rested in part on the “liberal federal policy favoring arbitration agreements,” [102] it also indicates that ambiguous mandatory arbitration clauses will likely withstand challenge.


The ramifications of mandatory arbitration clauses are threefold. First, these clauses prevent borrowers from choosing a forum in which to make their claim, [103] which can lead to added expense and inconvenience for the borrower. Even if the arbitration is relatively inexpensive, it prevents individual borrowers from joining in class action suits against predatory lenders. [104] As to more permanent remedies, arbitration cannot provide the injunctive relief needed to change lenders’ business practices. [105]


Even if a lending contract does not include a mandatory arbitration clause, a borrower faces an uphill battle in court. Many predatory lending contracts could be challenged based on the doctrine of unconscionability, codified by U.C.C. § 2-302. [106] E. Allan Farnsworth explains that although this provision technically only applies to the sale of goods, it has been extended to include all contracts subject to the U.C.C. [107] In Williams v. Walker-Thomas Furniture Co., the D.C. Circuit defined unconscionability as “an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other party… In many cases, the meaningfulness of the choice is negated by a gross inequality of bargaining power.” [108] Although Williams was decided over three decades ago, this description has remained the most “durable answer” of what unconscionability means. [109]


At first glance, the standard of unconscionability would seem to provide borrowers with legal relief, since one of the hallmarks of predatory lending is that the borrower misunderstands the terms of the contract, which weigh heavily in favor of the lender. Yet suits based on unconscionability are prohibitively expensive. One writer estimates that had plaintiff Williams paid for her attorney at a rate of $25 per hour (the market rate in 1965), [110] her legal fees would have totaled $5,250, nearly five times what she owed to Walker-Thomas Furniture. [111] Because predatory lenders target low-income people, few borrowers have the resources or sophistication needed to mount a successful unconscionability suit.


The securitization of mortgages further insulates predatory lenders from unconscionability claims. The “holder in due course” doctrine protects the bona fide purchasers of mortgaged-backed securities from claims based on the underlying mortgage. [112] Once a mortgage is assigned to a holder who does not have notice of unconscionability and duress, the borrower is barred from asserting such defenses to the enforcement of the lending contract. [113] The result is that predatory lenders can sell unconscionable loans to borrowers, securitize those loans, sell those securities, and protect themselves from most common law contract claims. The borrower takes on all of the risk associated with the predatory loan, and is precluded from asserting a claim of unconscionability under U.C.C. § 2-302.

69Private Suits under State UDAPs70

Borrowers can also file suit under their state’s Unfair and Deceptive Acts and Practices law, which provide for private causes of action against violators. There are a number of states whose UDAPs can be used against predatory lenders. Those states include Arizona, Illinois, Kansas, Michigan, New Hampshire and Pennsylvania. Richard Daugherty explains that North Carolina’s UDAP has a limited effect on predatory lending, because it uses language written in general terms.” [114] Yet it is precisely the definitional ambiguities of deceptive and unfair that may allow injured borrowers – or attorneys general acting on their behalf – to utilize their states’ UDAPs. “UDAP statutes are written in a broad fashion,” because their drafters recognized that “the meanings of unfairness and deception are to be developed over time, so that UDAP law can adapt to future business practices.” [115] Indeed, the State Attorneys General have used these statutes aggressively and to great effect in many areas that the UDAPs’ original drafters may not have foreseen.


However, as with unconscionability, some borrowers may face obstacles when suing based on UDAP violations. A handful of states’ UDAPs, including Ohio, Texas, [116] Georgia,[117] and Alabama,[118] are limited to “goods and services,” and thus do not cover predatory lending. [119] In addition, a borrower’s state UDAP may limit recoverable damages, which can make the suit unattractive to plaintiffs’ attorneys.

72Private Suits under Federal Statutes73

Finally, borrowers can assert claims based on numerous federal statutes, including the FHA, TILA and the RESPA, but private suits under these statutes cannot stave off the predatory lending. First, “the Fair Housing Act is not an effective tool for combating mortgage lending discrimination” since borrowers rarely know they have been illegally denied a loan based on their race, color, religion, sex, familial status or national origin. [120] Furthermore, in order to state a claim under the FHA, a borrower must show that the lender made mortgage loans to similarly situated borrowers of other races. But because the FHA does not include a reporting requirement, from which a plaintiff might gather such data, a borrower has little chance of proving such discrimination. [121] Finally, although some victims of predatory lending are minorities, the FHA cannot address predatory lending in non-minority communities.


TILA requires lenders to disclose the finance charge and annual percentage rate to borrowers. TILA does not, however, require disclosure of charges for credit reports, title searches, document preparation, and government taxes, all of which are frequent features of predatory loans. [122] RESPA requires lenders to disclose the good faith estimate of closing costs, [123] but RESPA gives lenders three days from the time of the loan application for disclosure. By that time, many borrowers have already paid the significant application fees imposed by predatory lenders. [124]


Part III: The Household Settlement


The settlement with Household marks the “largest direct restitution amount ever in a state or federal consumer case.” [125] Most early commentators have praised the settlement as a step in the right direction. [126] Because the settlement did not result from charges filed against Household, few public records document the agreement. This landmark raises a number of questions. First, how was the team formed to combat these formidable practices? How did that team assert jurisdiction over Household? As explained in Part II-C, supra, many state UDAPs do not cover predatory lending. What role did housing advocate groups like ACORN play in pressuring the State Attorneys General to investigate Household? Have these groups been satisfied with the results of that pressure? Finally, and most importantly, how did State Attorneys General leverage their past experience in multi-state litigation against Household?


A. The Multi-state, Multi-agency Team


The Household settlement more than doubled the FTC’s then-record-breaking settlement with First Associates. More revolutionary, however, was the fact that the negotiating team was composed of attorneys from the consumer protection and civil rights divisions of State Attorneys’ General offices and state banking regulators. [127]


Attorneys from the civil rights and consumer protection divisions of State Attorneys’ General offices had worked together in the past. In 1993, NAAG created a joint initiative with the U.S. Department of Justice to address mortgage lending. Sandra Kane, Assistant State Attorney General of Arizona, co-chaired the group with Sandy Ross of the DOJ. [128] This task force included attorneys from both civil rights and consumer protection divisions of State Attorneys’ General offices. Moreover, the mortgage lending task force already had experience with predatory lenders after its investigation of and settlement with FAMCO. [129]


The cross-agency barriers began to fall at the 1999 conference of the National Association of Consumer Advocates (“NACA”), [130] in Des Moines, Iowa. Kathleen Keest, Assistant Attorney General of Iowa, helped organize the conference. There, public enforcement officials discussed predatory lending. More importantly, “people from the FTC, Attorneys’ General offices, and financial regulators got to know one another.” [131] As a result, an “informal communications network” was formed that linked State Attorneys General and financial regulators. [132]


The state of Washington also played an important role creating ties between the State Attorney General’s office and the state’s Department of Financial Institutions. David Huey, Assistant State Attorney General of Washington (consumer protection division), explains that his state’s Consumer Loan Act provides that violations of its terms are also per se violations of the Consumer Protection Act. The DFI enforces the former and the State Attorney General enforces the latter. This provision caused the two agencies to work together closely. [133]


Yet working together was not without its challenges. Mr. Huey described a culture gap between the two groups. “Agencies, being bureaucracies, tend to…focus on paper. It is harder to mobilize an agency to take a license away, since they don’t see that as their function. But in the [State Attorney General’s office], we go after people; I like to call myself a plaintiff’s attorney in the largest defense firm in the state of Washington.” [134] Mr. Huey speculates that the “more aggressive enforcement elements of DFI were attracted to a relationship with [the State Attorney General’s office] because they knew we could bring both an aggressive tone and resources to the battle.” [135]


To strengthen the enforcement of the state’s Consumer Loan and Consumer Protection Acts, an “interoffice task force was created between the Attorney General’s office and the DFI in July 2001.” [136] The task force “identified targets” for an investigation. [137] Since “Household was high on both [agencies’] lists…it ended up being the lender we decided to look into.” [138] DFI spent the summer of 2001 gathering complaints from Household borrowers in that state. From the very start, banking regulators were heavily involved in the investigation.


The inclusion of state banking regulators in the multi-state team was crucial to the State Attorneys’ General case against Household. In the states whose UDAPs do not cover financial instruments, legislators had reasoned that lending institutions are already regulated – through licensing – by state banking agencies. Indeed, the deterrent power of the regulator is significant: in many states, the revocation of a license in one state is grounds for revocation in another state. “Consequently, there was a lot more leverage in this multi-state than in an Attorney General-only multi-state.” [139]


The state of Ohio is paradigmatic of the regulators’ importance. Because Ohio’s UDAP does not extend to financial instruments, [140] Betty Montgomery, then State Attorney General of Ohio, would not have had direct jurisdiction to sue Household. [141] The Ohio Division of Financial Institutions, however, has the authority to revoke a lender’s license based on unfair practices, [142] and hence was part of the multi-state team. This cooperation enabled the team to maneuver around jurisdictional issues that had stymied enforcement for decades. Household now faced a real threat of litigation, or worse yet, loss of its license. [143]


B. The Role of the Outside Agitator


ACORN ran its own campaign against Household. Chris Saffert, an ACORN representative in Brooklyn, New York, explained that his organization’s predatory lending campaign “focused on Household as a violator” starting in late 2000. [144] By summer 2001, while the Washington DFI was gathering complaints about the company, ACORN’s 53 offices “started a concerted effort,” holding “direct actions at many Household offices, when [they] handed out flyers warning borrowers about Household’s practices.” [145] In addition, ACORN’s “organizers were out in the field, knocking on doors, interviewing people who had problems with Household.” [146] The group “also gathered lists of the borrowers and did mailings asking for their complaints,” about the company. [147]


ACORN recognized that State Attorneys General would be critical to their national campaign against the lender, so the organization began filing as many complaints as it could gather with many State Attorneys General. Mr. Saffert explained that his organization wanted “to show that borrowers were worse off in every respect, and that Household had sold them loan terms that were different from the actual loan they received.” [148]


ACORN’s efforts were met with mixed responses from the State Attorneys General. While some offices simply forwarded the complaints to Household, others were very receptive. In Washington, for instance, ACORN brought David Huey’s team complaints from the Seattle area, which may have “spurred them to do a larger investigation.” [149] Saffert identified Minnesota, Massachussetts, New York, Arizona, California, and Iowa as the states most interested in pursuing Household.


Ms. Keest and Ms. Kane confirm ACORN’s role in Household. In Arizona, ACORN filed complaints with State Attorney General Janet Napolitano’s office about mortgage loans made to Hispanic borrowers who could not read their English loan documents.[150] Ms. Keest explained that ACORN 2001 campaign was “absolutely key” to Iowa’s investigation because victims of predatory lending often fail to file complaints with their State Attorney General. “They usually do not know the law, and so don’t know that a lender may have violated [it]; they may not feel comfortable talking about financial troubles (especially the elderly); they may just feel they have made a bad decision and will have to live with it.” [151] ACORN acknowledged that it is “difficult to get people to feel comfortable about talking about their problems with money.” [152] However, as an organization, “ACORN has experience helping people overcome their doubts and fears that they were alone or were at fault. We helped people see the problem on a broader scale, by getting them involved in the campaign and taking leadership roles.” [153]


While ACORN had considerable institutional experience in gathering consumer complaints, its aggressive practices were not universally well received by the members of the multi-state team. David Huey stated that half the team, including himself, viewed ACORN as “an ally, with a corresponding interest in the investigation.” Another set of public attorneys viewed ACORN as “less rational…on the fringes, prone to do things like show up at offices, chanting with signs.” [154] Indeed, in April 2002, ACORN led 20 customers in a protest at Mr. Huey’s office in Washington. Mr. Huey recognized that this protest was not directed at his office, but his more conservative colleagues, who “don’t want to see their picture in the paper or be quoted,” felt anxious about being linked to ACORN. [155]


Although not all of ACORN’s complaints were met with prosecutorial vigor, Ms. Keest explained that they continued to play an important role within the State Attorney General world. In response to ACORN’s campaign, “e-mail communications went through three separate channels – the banking regulatory channel, the AG CPD [Consumer Protection Division] channel, and the informal predatory lending and NAAG mortgage lending channel.” [156]


C. The Rogue Office Defense


In May 2002, the Washington DFI announced that “in a routine examination” of Household offices the previous summer, “it uncovered violations of the state’s Consumer Loan Act,” by refinancing existing loans and charging points on the balances of both loans, in violation of the Act. [157] Although Household attributed this violation to a computer error, [158] the DFI’s investigation led to increased media attention on Household.


The DFI planned to release a report of 179 complaints from borrowers about Household later that same month. Mark Thomson, then acting director of the Washington DFI, distinguished these complaints from the aforementioned overcharges as “about sales and origination practices and people not understanding the terms of the loans they entered into.” [159]


The Washington DFI’s report contained information about Household’s lending practices that could potentially damage the company’s already falling stock price. [160] David Huey told the press that the report contained “some serious allegations about misrepresentations that [Household] made to people and potentially unfair practices that they engaged in. We’re looking into their activities and we may be doing something about it.” [161] In reality, of course, Mr. Huey’s office had been working with the DFI for some time. During the last week of May 2002, Household raced to court to stop the release of the report. Thurston County Superior Court Judge Daniel Berschauer issued a temporary restraining order against the DFI’s release of “any information or documents obtained in connection with any investigation of Household’s lending practices.” [162] But the damage Household feared became a reality when the DFI’s report leaked to the press soon after the injunction. [163]


In response to this growing list of allegations, Household lowered the interest rates of its Bellingham, Washington customers who had joined a lawsuit against the company. The spokeswoman of Household stated that “ [Household] took full and prompt responsibility…[and was] satisfied that this situation was localized to the Bellingham branch.” [164] In essence, Household was arguing that a “rogue office” had “gone bad,” resulting in the evidence of predatory lending. [165] Moshe Orenbuch, a consumer finance equity analyst at Credit Suisse First Boston, echoed this line of defense when he told reporters “no doubt you find instances where an individual was disadvantaged, but I don’t think it’s a systematic approach.” [166] This defense tactic was a potential setback for enforcement officials in the various states.


The defense failed. By June 2002, sixteen states were involved in the Household investigation, represented by either a banking regulator, a State Attorney General’s civil rights division, a State Attorney General’s consumer protection division, or by both a regulator and State Attorney General. [167] Household’s rogue office story clearly could not survive the continued scrutiny of ACORN and the multi-state, multi-agency team. Ms. Kane said that the team realized they “were all seeing the same thing,” in their respective jurisdictions. [168] A “rogue office…story can only go so far when the same practices are found from Massachusetts to Washington, and from Minnesota to Florida.” [169] As a national organization, ACORN helped to discredit Household’s defense by filing complaints with Attorneys General in numerous states. [170]


D. The Settlement Negotiations


Many observers have questioned Household’s willingness to settle so quickly with the multi-state team. [171] In the prior major predatory lending case, First Associates had spent years negotiating with the FTC. The stock market seems to provide the most salient explanation for the rapidity of the settlement.


Although “the existence of the multi-state [investigation] was supposed to be confidential, rumors were flying,” in addition to the news of the Washington DFI’s investigation and suits filed by borrowers and ACORN in California, Washington, Illinois. [172] When the DFI’s report leaked in late spring, Household’s stock price began slipping, from a high of $62 per share in May to less than $50 in June. By the third week in July, Household stock was trading at $36 per share.


By fall 2002, Household’s stock price had been falling for many months, to reach $22. Equity research analysts at Sanford Bernstein issued reports that lowered their earnings estimates for Household, based in part on the threat of litigation. [173] With each state added to the multi-state team and each new article discussing its lending practices, Household witnessed yet another drop in its market capitalization. Rather than face this continued financial disaster, the company “wanted universal peace,” rather than brokering piecemeal settlements with different states. [174] By requiring states representing 80% of its borrowers to sign on to the agreement, Household no longer “faces the possibility that six months or a year later the same issues [might] come up from a non-settling state.” [175]


On November 14, 2002, HSBC announced its plans to acquire Household for $14 billion. [176] Negotiators for the states have universally denied knowing about the deal prior to its public announcement. [177] One can conjecture that Household’s management wanted to settle its potentially messy lawsuits with the states to facilitate the acquisition, but kept its plan under wraps to avoid giving its opponents a bargaining tool. Other commentators have hypothesized that the settlement itself forced Household to the auction block. In fact, few individuals know what role, if any, HSBC played in the settlement negotiations with the multi-state team.


E. The Settlement Terms


The final negotiations team combined State Attorneys General and financial regulators. It was lead by Tom Miller, Iowa State Attorney General, Christine Gregoire, Washington State Attorney General, Roy Cooper, North Carolina State Attorney General, and Elizabeth McCaul, New York State Superintendent of Banks. Household has agreed to the following terms:

  • Limit up-front points and origination fees to 5%
  • Limit prepayment penalties on current and future home loans to the first two years of a loan
  • Reform and improve disclosures to consumers
  • Eliminate "piggyback" second mortgages
  • Ensure that new home loans actually provide a benefit to consumers prior to making the loans
  • Reimburse states to cover the costs of the investigations into Household's practices
  • $484 million in relief to Household borrowers

Those involved with the Household settlement are almost universally pleased with its terms. Many observers, including ACORN, identify the two-year prepayment penalty limit as the most important feature of the settlement, since it permits borrowers to take advantage of lower interest rates. Some states (such as New York) had already legislated against prepayment penalties. When the OTS promulgated its new rule in September 2002, allowing the states to regulate prepayment penalties, those laws will finally ban the practice. Furthermore, “for those states which do still allow [prepayment penalties], there are good provisions in the injunction,” to protect borrowers. [180] Ms. Keest explains that “TILA [the federal statute] only requires a vague statement that ‘you may have to pay a prepayment penalty’ if there is one…I defy anyone to look at the note language in Household [loans] and figure out how this clause translates to dollars. I can do it – so long as I can run an amortization chart.” [181] So in addition to limiting the penalty period to two years instead of five years, under the Household settlement “consumers have to be told in dollars what the maximum [penalty] amount could be.”


The monetary relief of $484 million is the largest recovery from a predatory lender in history. Ms. Keest acknowledged that “no affected consumers will be made 100% whole. But then neither would any other process.” [182] David Huey agreed when he stated that

    settlements have advantages and disadvantages. People criticize the settlement for failing to get 100% relief for borrowers…but we were not choosing between 100% relief and 50% relief; no one would write me a check for 100%. If we were willing to compromise, we could get more injunctive relief. [183]

The reimbursement of investigation costs is a boon to the states. Ms. Kane said that she has witnessed greater interest among her colleagues to pursue predatory lending cases, in part because of the recovery of attorneys fees.


ACORN has also expressed its approval of the settlement terms. Chris Saffert said that “the terms are very similar to the ‘best practices’ Household had announced,” [184] in Spring 2002 in response to the leak of Washington’s investigation. But whereas “the best practices are not binding on Household, a consent decree with the State Attorneys General is binding. If Household violates the decree, we can pursue that violation and get punitive damages.” [185]


Part IV: Household as a Blueprint


Household and Other Lenders


The Household settlement can be a powerful tool against other lenders. The settlement terms themselves may act as de facto regulations of other mortgage lenders. David Huey reports that representatives of other financial institutions have told Christine Gregoire, State Attorney General of Washington, that they have met or exceeded all of the provisions of the Household settlement. “They already perceive, as we do, that this is a new day, and there are standards they [the lenders] need to meet.” [186] Ms. Kane explained that on a broader scale, “consciousness has been raised” by the Household case. [187] “A few years ago, people denied there was any predatory lending in [Arizona]. Now the industry is admitting there is a problem.” [188]


Perhaps more importantly, the unique multi-state, multi-agency team may be used against other predatory lenders. The replication of that group will not, however, be without its hurdles. Multi-state litigation brings with it multi-state goals and “frustration.” [189] It often “proved more difficult to get a consensus among the fifty states than to deal with Household.” [190] For example, New York law prohibits prepayment penalties after the first year of a loan. The New York representatives did not wish to compromise monetary relief in exchange for a two-year prepayment penalty limit that would not provide additional protection to its constituents. Yet states without predatory lending laws needed the Household settlement to fill that legislative gap.


In addition, ACORN’s somewhat radical techniques caused discomfort among some in the multi-state team. If members of the multi-state team do not wish to “see their picture in the paper or be quoted,” working with ACORN may prove challenging. [191]


The cultural differences between regulators and state attorneys may also stymie future multi-state multi-agency litigation. “Banking superintendents are very reluctant to take on the industry,” explained Ms. Kane. [192] “They don’t think there is predatory lending; they . . . see that the documents have been signed and conclude it was not a predatory loan.” [193] This description sharply contrasts with Mr. Huey’s view of his role as Assistant Attorney General as that of a “plaintiff’s attorney.” [194]


These barriers are, however, surmountable. First, Mr. Huey explained that while the Household multi-state was “not an uncommon arrangement for [attorneys] in consumer protection,” combining attorneys from both civil rights and consumer protection divisions proved to be an important factor in the settlement. As explained in Part I-B, supra, predatory lending disproportionately affects minorities. Attorneys like Sandra Kane, who have experience dealing with civil rights issues, can bring important perspective to the table. Moreover, attorneys from civil rights divisions can rarely charge predatory lenders with civil rights violations since statutes require evidence of purposeful targeting, which is often difficult to prove. Hence it is often “much easier to prove consumer fraud than it is to prove a civil rights violation,” making the combination of civil rights and consumer protection attorneys critical to an investigation’s success. [195]


Secondly, while ACORN’s radical tactics may not sit well with the risk-averse members of the multi-state team, their ability to arouse public interest in the Household case could also be used in the future. [196] Attorney General Miller agreed that “Household was under a lot of pressure from the public and the investment community and the press. That was an intangible at play, and ACORN had some effect, and may have indirectly added to our bargaining position.” [197] Moreover, ACORN’s ability to gather complaints was critical to proving that Household’s predatory practices existed beyond the state of Washington. Because of those complaints, the multi-state team “started to contact each other and compare notes, to affirm that [it] was not an isolated case.” [198]


Finally, the collaboration between State Attorneys General and banking regulators can be replicated in future cases. In many states, including Washington, California and New York, attorneys from the State Attorney General office and banking regulators worked on Household. The contacts made during the six month investigation can be used against other predatory lenders in the future.


Attorney General Tom Miller acknowledged that “getting all of the Attorneys General to come to a consensus is hard enough, but we are a family. To go outside the family to get consensus [with banking regulators] would be even more challenging.” [199] Yet the new recipe worked. General Miller said “for the two months I was involved, the working relationships with the financial regulators exceeded all of my hopes.” [200] Unlike the stereotype of bureaucrats as risk averse conservatives, Attorney General Miller described the regulators, especially those from Washington, Minnesota and New York, as “the hardliners, the toughest negotiators in the group.” [201] This description ratifies Mr. Huey’s sense that the “more aggressive enforcement elements” of the banking regulators were attracted to the Household case. [202] Nothing should stop that unit from working together again – “it is just a natural success if you can get over petty jealousies.” [203]


Without the critical mass of information from ACORN, the states might be tempted to adopt a parochial, rather than national, perspective. But due to the “shifting political winds . . . and constraints on the FTC’s enforcement resources,” [204] the states should not cede to the federal government for a national solution to predatory lending. The under-regulation of the mortgage lending market is analogous to the Reagan era, when federal agencies lacked the resources to enforce antitrust laws. The State Attorneys General responded by filing highly coordinated multi-state antitrust cases to protect consumers. [205] Using the Household model, the State Attorneys General could perform the same role for borrowers injured by predatory lenders. In addition, attorneys from NAAG and the DOJ already work together on the mortgage lending task force lead by Ms. Kane. Leveraging that relationship could overcome political obstacles and provide considerable bargaining power to state and federal law enforcement officials.


Bargaining as a team provides greater leverage against lenders and relief for borrowers. For example, before the multi-state team had formed, the state of Minnesota negotiated a $200,000 consent order with Household. In comparison, Minnesota borrowers received $5.5 million under the multi-state settlement.[206] The multi-state team thus brought both law enforcement success and private financial relief. For this reason, Attorney General Miller said that he “expects this group to work together again in the future,” and that he and his colleagues will “return to the Household terms as the starting point for defining a remedy.”[207]


B. Household and Other Entities


The Household multi-state team broke a law enforcement logjam. Legislation has largely failed to stop lenders from using predatory practices, and is subject to amendment. Private suits against predatory lenders have proven to be nearly impossible to win. By thinking creatively about jurisdictional gaps and leveraging the strength of its many members, the Household team won permanent injunctive relief that will help thousands of borrowers reach their goal of homeownership.


The Household settlement may also presage the future of law enforcement. Attorney General Miller explained that combining regulators and Attorneys General has already met with success in law enforcement outside the lending industry. Like the Household settlement, the investigation of investment banks exemplifies this new model. State Attorney General of New York Eliot Spitzer has led the investigation of financial institutions. Only Spitzer and three other Attorneys General have jurisdiction to pursue securities violations under their states’ laws. In the forty-six remaining states, another official has jurisdiction. “The Attorneys General are a small minority, even though Eliot [Spitzer] is their leader.” [208]


Law enforcement attorneys can extend the Household paradigm beyond banking and lending. Consider a hypothetical retailer with stores in all fifty states. A State Attorney General receives labor complaints about the retailer, and decides to look into the matter. [209] According to the status quo, the state’s department of labor investigates the retailer’s wage and hour violations at stores within state borders. With sufficient data, the State Attorney General negotiates a settlement agreement for the company’s state violations.


But what if this breach is not due to one rogue manager, but instead indicates a systemic, nationwide practice of wage and hour violations? Under the new model, a task force composed of State Attorneys General and labor department officials from multiple states compares the violations witnessed within each state – perhaps employing the help of a grassroots organization like ACORN to gather complaints – to determine whether this national company has a national problem. Negotiating with the retailer as a unit, the team uses both licensing and litigation as leverage, extracting far greater injunctive and monetary relief than would be possible under the status quo.


In light of the consolidation of the nation’s retail, manufacturing and service industries, many violations which appear isolated likely represent systemic problems. By combining licensing officials with State Attorneys General, the new model can aid the enforcement of labor, civil rights, disability and even environmental laws. To replicate the success of Household, the State Attorneys General must reach beyond both state borders and their own offices, to fellow attorneys, licensing officials and administrative agencies. With creative thinking and cooperation, the Household model can continue to uncork law enforcement bottlenecks.

134December 20, 2006

HSBC Sours on American Loans
Consumer-Lending Portfolio
Creates Indigestion Four Years
After Swallowing Household Unit
December 20, 2006; Page C1

193March 6, 2009
The Deal That Fueled Subprime




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December 04, 2014

How the Household Settlement Uncorked a Law Enforcement Bottleneck

How the Household Settlement Uncorked a Law Enforcement Bottleneck by Sally Peacock

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