Daily Development for Thursday, October 24, 2002

By: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
prandolph@cctr.umkc.edu

MORTGAGES; FEDERAL REGULATION; PREEMPTION: The Alternative Mortgage Instruments Parity Act remains effective as a preemption of state alternative home mortgage instrument regulation aimed at curbing "predatory lending," notwithstanding the fact that Congress in 1994 itself enacted some provisions that limited predatory practices. The 1994 Act does not displace and supercede the 1982 Parity Act, and the Parity Act is neither too vague too enforce nor susceptible of evasion by state regulators.

Illinois Assoc. Of Mortg. Brokers v. Office of Banks and Real Estate, No. 02-1018 http://caselaw.lp.findlaw.com/data2/circs/7th/021018p.pdf (7th Cir. 10/21/2002)

Judge Easterbrook here confronted the Illinois lending regulatory establishment and concludes that Illinois cannot regulate the practice of combining balloon mortgages with alternative interest rate loans, because alternative interest rate loans, at least, are "alternative mortgage instruments" and subject to the federal preemption provisions of the Alternative Mortgage Instrument Parity Act of 1982. The Parity Act has been around for a long time, and largely ignored, until recent concerns about predatory lending and the rise in independent mortgage brokers inspired state and local governments to become much more active in enforcing consumer protection in the home finance marketplace.

The definition of what constitutes an "alternative" lending practice is very broad, but certainly encompasses adjustable interest rate loans and probably also balloon mortgages and any device other than a traditional long term fixed rate level debt service loan.

In a nutshell, as to the lenders covered - basically most institutional lenders - the Parity Act provides that there can be no state or local regulation of lending practices in alternative mortgage loans. Such loans are regulated only under the same rules promulgated by federal regulations for the behavior of federally chartered institutions. In other words, as to alternative lending practices, the Act creates a "level playing field" between federally chartered lenders - which would be exempt from state and local regulation anyway - and all other institutional lenders who would not otherwise be so exempt. This playing field was left relatively unobstructed in order for "the market to work."

Illinois regulators argued that the Parity Act not only should not reach that broadly, but should in fact not restrict their regulations at all.

There was a dizzying array of hypertechnical procedural detail in the case - enough to warm the heart of any mortgage regulator, although it had to with standing, exposure to lawsuits, and the like, which had nothing really to do with mortgage law.

The heart of the Illinois and City of Chicago argument, however, was a complex turn on the preemptive policies of the federal government. The 1994 Home Ownership and Equity Protection Act, a federal enactment, forbids lenders from using particular identified terms in loan transactions. As parallel federal legislation, of course, this Act obviously superceded the Parity Act with respect to matters covered. But the state and local interests argued it went further, and totally displaced the Parity Act, rendering it a nullity.

The Fifth Circuit refused to bite. The Parity Act remains in effect, preempting state and local law, regardless of what other conduct might be restricted by other provisions of more recent federal law.

But, contrary to some earlier views of the scope of the Parity Act, the Court of Appeals held that state and local anti-predatory lending ordinances were not per se preempted. Federal preemption only occurs when (1) a state or local regulation directly conflicts with federal law, or (2) state laws transgress into areas identified by the OTS as preempted under the Parity Act. The court noted:

"At one time the OTS believed that state lenders always could use whatever terms were lawful for federal lenders. More recently, however, the OTS has taken the position that only federal regulations accompanied by a declaration of preemptive force affect state law. See 67 Fed. Reg. at 60548 n.36. On this view states may put off limits to state-chartered lenders some of the terms that are lawful for federal lenders. The district court must determine which of these views is legally correct and then ascertain which provisions of the state regulations are incompatible with the federal regulations now in force."

The Court of Appeals remanded the case back to the District Court "with instructions to dismiss the Office of Banks and Real Estate as a party and to issue a declaratory judgment resolving which state regulations are preempted by the combination of 3803(c) and the OTS regulations governing federal lenders."

The City of Chicago also tried to argue that since the Parity Act only applies to licensed lenders, the City and State could set standards for loan terms offered by state lenders, and revoke their licenses if these loan terms were not followed. This would prevent the lenders from making the loans that the City wanted to regulate. Of course, it would be a naked attempt to "end run" the Parity Act and the federal regulatory umbrella it raises. The Court congratulated the State of Illinois for not trying to make this argument in its presentation:

"Smuggling the regulation of terms into the criteria for issuing licenses, and then arguing that state-chartered lenders lose all benefits of the 1982 Act, would be a stunt unworthy of the State of Illinois-and ineffective as a matter of federal law."

Reporter's Comment: Here's how Howard Lax, a noted commentator on federal regulation of lending practices, discusses another central debate in the case:

[The Illinois regulator interests] argued that when Congress passed the [1992 Act], these laws were incorporated into the framework of federal lending rules that "preempted the field" of laws for federal savings associations under the Home Owner's Loan Act and, therefore, federal savings associations did not have to follow state and local anti-predatory lending rules. [The Illinois regulator interests] then bootstrapped this argument into an argument that the Parity Act gives state chartered mortgage lenders the benefit of "preemption of the field" of lending regulation for alternative mortgage transactions that is available to federal savings associations, since this is the only way that state chartered lender can have true "parity" with federal savings associations. This is an argument that a younger sibling makes to a parent: "When Tommy gets to stay up until midnight, so should I." While it is true that federal law gives state lenders parity with federal savings associations for alternative mortgage transactions, the parity only exists to the extent that the OTS identifies specific federal rules as applicable to state lenders making alternative mortgage transactions.

Editor's Comment 1: It is clear that the OTS is not willing to go to the wall with an argument that the Parity Act preempts all local regulation of alternative mortgage instrument practices, although at one time this was commonly believed to be the case.

Editor's Comment 2: A prior decision in which a court concluded that the Parity Act did not provide complete preemptive protection is Black. Financial Freedom Senior Funding Corp.\112 Cal.Rptr.2d 445 (Cal. App.

2001), cert. den. 122 S. Ct. 2662 (2002) , the DD for 10/16/01.

Editor's Comment 3: The most recent rules promulgated by the OTS under the Parity Act appear at 67 Fed. Reg. 60542 (9/26/02) The official summary read as follows:

"The Alternative Mortgage Transaction Parity Act (AMTPA) authorizes state chartered housing creditors to make, purchase, and enforce alternative mortgage transactions without regard to any state constitution, law, or regulation. To rely on AMTPA, certain state chartered housing creditors must comply with regulations on alternative mortgage transactions issued by the Office of Thrift Supervision (OTS).

In today's rulemaking, OTS revises its rules identifying the OTS regulations that apply under AMTPA. OTS will no longer identify its regulations on prepayments and late charges for state chartered housing creditors."

Reporter's Comment 2: Here is Howard Lax's commentary on the recent amendments:

"Prepayment fees have become an integral part of loan pricing for many subprime loan investors. The revised OTS rule may thrust loan pricing above the reduced Section 32 threshold for many lower credit quality borrowers, but allow a shorter turnover time for borrowers who wish to refinance their loans upon improving their credit score. Sophisticated mortgage brokers may be better able to refinance subprime loans, and they will have to - their per loan income is likely to drop as yield spread premiums for subprime loans are reduced due to the likelihood of refinance transactions. We may see some lenders reintroduce exotic loan program features, such as limited term shared appreciation clauses, to substitute for prepayment fees."

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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