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As consumers are waking up to a world of crashed housing markets, bad loan pileups, and countless dollars spent in the weird fun house of “subprime” lending, the Supreme Court has made things (not) a bit easier. The Court’s April decision in Watters v. Wachovia, although it establishes new precedents in the mortgage industry, cannot be called consumer-friendly. If you want fair play when you take out a house loan, the justices seem to be saying, hire a lawyer to cover every move you make. Otherwise, you’re on your own. In Watters, the Court ruled that a federal banking agency, the Office of the Comptroller of the Currency, has sole authority to regulate the activities of a national bank’s state-chartered mortgage subsidiary. This is not a victory for meaningful oversight, even with the agency’s June 29 statement about predatory lending. The agency announced a new cooperative regime with state agencies to comply with federal consumer protection standards. The current OCC regulations, which became effective in 2004, declare that states may not impose “burdensome” consumer protection requirements that would “interfere” with the ability of national banks to make loans. Ironically, the decision comes at a time when regulation of mortgage subsidiaries has been lax and consumers virtually unprotected in the home mortgage market. Values of real property are plummeting in most markets across the country, and the nation is experiencing a flood of bankruptcies, loan defaults, and tragic consumer errors by loan seekers. The Supreme Court is not solely to blame for this, of course, but its Watters decision is part of the problem, and the ruling comes at a particularly unfortunate time when serious banking reform is urgently needed. NO STATE INTERFERENCE Wachovia Mortgage, initially a state-chartered, nonbank subsidiary of Wachovia Bank, made loans in Michigan for six years before becoming a wholly owned operating subsidiary of Wachovia Bank in 2003. It then notified the Michigan Office of Financial and Insurance Services that it would continue to issue mortgages without registering with the OFIS. (Thanks, guys.) The subsidiary justified its decision based on the OCC’s regulation that bars state officials from suing in state or federal court to enforce laws against national banks and their operating subsidiaries. Michigan’s OFIS commissioner, Linda Watters, responded by telling Wachovia Mortgage that it was violating Michigan laws and would have to discontinue its operations in the state. Wachovia Bank and Wachovia Mortgage filed suit, arguing that the OCC was the appropriate regulator of both the federally chartered bank and the state-chartered mortgage subsidiary. The case worked its way up to the Supreme Court. Consumer protection groups were rightly looking to Watters to clear up the muddy lines between national and state banking laws�lines that were having an adverse effect on the housing market through the out-of-control behavior of subprime lenders. Clarity, yes. Satisfaction, no. The Supreme Court held that the National Bank Act gave national banks the power to engage in real-estate lending through an operating subsidiary, and state law cannot significantly impair or impede this power. Accordingly, the Court concluded that “state regulators cannot interfere with the �business of banking’ by subjecting national banks or their OCC-licensed operating subsidiaries to multiple audits and surveillance under rival oversight regimes.” MICHIGAN’s INTEREST From Michigan’s perspective, the statute in dispute made perfect sense. It protected Michigan’s interests in overseeing any and all banks doing business there. Both consumers and businesses there could rest assured that the state could investigate if a bank or subsidiary operating there was behaving in a predatory manner by offering equity-stripping, abusive loan products. Seems like a good idea, especially in a state with a volatile economy driven largely by the auto industry. The last thing it needs is any bank making a lot of really bad loans. Both state-chartered and federally chartered banks and their subsidiaries are making lots of those. Certainly the state of Michigan has an interest in protecting consumers from possible exploitation by investigating consumer complaints. America’s dual banking system is a model of cooperative federalism. Banks may choose to have either a federal or state charter and thus choose whether they will be regulated by the state or federal banking laws. (All banks, however, are subject to the capital reserve requirements of the Federal Reserve and to examination by the Federal Deposit Insurance Corp.) But state law still applies on lots of issues. The real economic problem, lurking beneath the statutory pre-emption debate in Watters, is how to regulate predatory lending. Predatory lending is making loans with terms structured to harm borrowers, usually without transparent pricing. That’s a consumer law issue�which is “quintessentially” addressed by the states, as Justice John Paul Stevens put it in his minority opinion. Yet the Court removed the ability of states to address the problem, at least when it occurs with wholly owned subsidiaries of national banks. Watters is a change in the status quo, and not for the better. What Watters changes, however, is perhaps even more fundamental. Now what we have is a tilted playing field between the states and the feds, with the feds getting all the best shots. Now only the subsidiaries of state-chartered banks are subject to state statutes, such as the Michigan one allowing consumers to seek an investigation of a bank’s subsidiary. FEDERAL PROTECTIONISM Adding to this grievance, the Court’s decision fails to consider the OCC’s inherent conflict of interest. After all, what is the OCC’s role in the whole of the banking system? It’s really to regulate national banks. Instead, it has become protectionist�promoting the interests of national banks over those of state banks. In this scheme, federally regulated banks have a competitive edge in an economically vigorous industry, because the OCC has issued regulations that exempt national banks from complying with state predatory lending laws. They can drive out competition from state-chartered subsidiaries. Smaller state-based banks are particularly vulnerable. And when the state banks are forced out, a less competitive market hurts consumers because they have fewer lenders and products from which to choose. We’ve seen how this regulatory framework operates in the past decade. Consolidation has been the watchword among this part of the financial industry, as smaller, state-based banks have been bought out by “mega” corporate entities. Certainly these megabanks don’t feel all that beholden to the consumer–protection laws of Iowa, South Dakota, or Michigan. They do what they do�grow, then grow some more. FINANCIAL RUIN All this bank consolidation has not been good for the economy. Right now, we’re suffering through an immense crisis in the mortgage sector. As the subprime market collapses, an estimated 1.1 million homeowners face foreclosure and financial ruin. Obviously, no regulatory body at any level has properly handled this situation. Now, parts of the industry itself are brushing off the dirt and trying to repair some of the damage. Just days before the Watters opinion, Freddie Mac announced plans to dedicate $25 billion to refinance a portion of those ripped-up subprime loans. As incredible as that amount is, it’s hardly enough money to fix the problem. Moreover, the June actions of the OCC itself indicate that something must be done. No supervisory body, state or federal, can continue to ignore the devastation as people’s financial lives are ruined by reckless lenders. Industry proponents like the decision in Watters. Yet they’re honest enough to admit that some egregious behavior has taken place in the mortgage business, and they know it needs to be addressed. Watters was not the way to go if the goal is to stop abusive and bad lending practices. And perhaps this is not an issue for the courts. Congress must step in and address the problems of unfair lending in the subprime market. Predatory loans won’t stop until brokers and lenders have more regulation. Congress can shift the balance. A partial solution that gives borrowers more recourse is to regulate mortgage brokers to have a fiduciary duty to borrowers. This duty to act in the best interest of consumers would take away the mortgage brokers’ incentive to make abusive loans that harm consumers. Consumers also deserve transparency in all loan transactions, with simple terms and contracts that state clearly, accurately, and specifically the fees, interest rates, and how much the broker is being paid. We’ve had our run of fun in the banking industry for a long time now. It hasn’t been good for a lot of folks. Here’s hoping Watters is the last case of its kind for a long, long time. And Congress fixes the problem before it’s too late.
Cassandra Jones Havard is an associate professor at the University of Baltimore School of Law, where she specializes in banking, contracts, and business organizations.

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