AMERICAN PREDATORY LENDING AND THE GLOBAL
FINANCIAL CRISIS
ORAL HISTORY PROJECT
Interview with
Kathleen Keest
PREFACE
The following Oral History is the result of a recorded interview with
Kathleen Keest, conducted by Andrew O’Shaughnessy on May 28, 2020. This
interview is part of the Bass Connections American Predatory Lending and the
Global Financial Crisis Project.
Readers are
asked to bear in mind that they are reading a transcript of spoken word, rather
than written prose. The transcript has been reviewed and approved by the
interviewee.
Transcriber:
Andrew O’Shaughnessy Session:
1
Interviewee: Kathleen Keest Location: By Zoom
Interviewer: Andrew O’Shaughnessy Date:
May 28, 2020
Andrew O’Shaughnessy: My name is Andrew O’Shaughnessy, a J.D.
candidate at the Duke University School of Law, and also a research assistant
for the Global Financial Market Center’s American Predatory Lending Project. It
is Thursday, May 28, 2020. I am speaking remotely with Ms. Kathleen Keest for
an oral history interview. Ms. Keest, thank you for joining me today.
Kathleen Keest: Pleasure to be here. Sounds like
an exciting project.
Andrew O’Shaughnessy: That’s the ambition. I'd like to start by
establishing your early background. I believe you grew up in Illinois and got
your J.D. from the University of Iowa. So a Midwesterner at heart then.
Kathleen Keest: Yes, indeed.
Andrew O’Shaughnessy: You’ve had a varied career. You've
represented consumers directly, you've worked in policy and you've also worked
in government as a regulator and a consumer of policy. So in the context of
your career, when did you first start working on issues related to residential
mortgages?
Kathleen Keest: The first one was 1984. And
pretty much since the mid-eighties.
It
might be useful just in terms of setting a framework for you to understand the
way I view the timeline. I think of the subprime mortgage lending, in the run
up to the crisis, as three major waves of predominant business models.
What
I call the first wave basically ended with the 1994 HOEPA Act, the Homeowners’
Equity Protection Act. There were kind of two different business models [in the
first wave]. One was the big, national finance company model that had started
as small loan lenders. What they did in the late seventies, early eighties, was
move their business model into home-secured lending from small loans. And that
business model was exclusively refinance, not purchase money; high interest
rates; [fee] packing and flipping.[1] That was the Household[
International]’s, Associates [Home Equity Services], Beneficial[ Loan
Corporation of America]’s — those actors.
The
second [of the first wave models] was sort of a more regional one. In the late
eighties, early nineties, there was a period of rolling recessions in some
areas, followed by housing bubbles, big markups and housing appreciation. In
this business model, smaller more regional operators would make one- to
two-year balloon loans that were designed to fail and capture the appreciation
in these appreciating markets. If the people couldn't make the one- or two-year
balloon payment, which most of them couldn't, [the lenders would] foreclose and
get a more valuable property. If the [consumers] did find somebody to refinance
it, the lenders could take the money and run anyway.
And
kind of like generals fighting the last war, the 1994 [HOEPA] Act was designed
to bring an end to the balloon model, foreclosure-prompting ones, and curb the
excesses of the packing and flipping of the larger companies’ model without
really taking aim at the core of the [finance company] business model.
The
[finance companies] were charging, typically, around 15 or 18% [interest] on
these home secured-lendings, and 10% of the principal would be fees of some
sort. And HOEPA just knocked those [fees] down to 8%. So you started seeing,
you know, 14%, 15% rates with 7.9% fees and points, and a lot of insurance
packing because originally they — the [Federal Reserve] and the Congress — didn’t
count the single premium insurance towards the [8%] limit. (And we’d told them
at the time, in 1994, “you’re just inviting trouble, and you know that's what
they're going to continue to do.”) Sure enough, the second wave business model,
the period between when HOEPA went into effect in 1995 to around 2002, the
second wave business model was the finance company model, and they were in fact
doing a lot of insurance packing because those [fees] didn’t count towards the
8% rule. And that's when North Carolina started getting interested in passing a
new law. And that's when Martin Eakes [CEO of Self-Help Credit Union] noticed
what Associates was doing.
Between
1998 and 2002, there kind of started to be a pincer movement on that business
model. The FTC and the North Carolina AG’s office went after Associates for its
insurance packing. The North Carolina anti-predatory lending law took aim at
that in 1999. [The state AGs and financial regulators started the Household
investigation.] Then, I think it was
somewhere between 2000 and 2002 that the Fed finally….
To
back up a minute, we were telling them in 1994 that credit insurance was going
to be abused if they didn't count it [towards the 8% limit]. The [HOEPA}
compromise was to give the Fed authority to add it to the fees and points
triggers. So sometime between 2000 and
2002 – I don't remember exactly when – the Fed did do that.
And
so that was the pincer movement that started in on the second wave model and
[helped cause] it to wane. And in the
meantime, what I call the third wave, which is the hybrid, the exploding ARMs
[adjustable-rate mortgages] started coming in, and that was partly their moving
into the vacuum that was left. And that's the [model] where [the loans are]
“designed to sell” and “designed to terminate early” so they could continue
feeding the demand from the securitization market. So that's kind of the
timeline.
We
were focusing on the very end of this what I call the second wave, and the
beginning of the third wave, which are two different business models. The
legislation and the regulatory responses and the law enforcement kind of — because
they're backward looking, you know — they’re focusing on the end days of wave
two business model, while we hadn't yet seen the problems inherent in the third
wave.
I
mean it's kind of interesting to me that in 1994, when we were working on the HOEPA
legislation, the people in Congress – even those who were wanting to do the
reforms – are saying, “We don't want to interfere with the responsible subprime lenders.” And
at the time, Household was considered one of the “responsible” subprime
lenders. Fast forward to 2000 – I think it was 2000, 2001 – when there's a
[U.S. Senate] hearing on predatory lending which is focusing on the second wave
finance company model. And I remember at
that point I was working for [Iowa Attorney General] Tom Miller. Tom Miller and Martin Eakes and a consumer
from West Virginia were on a panel with a guy from AmeriQuest, which was one of
the biggest lenders of the third wave model.
And at that point, AmeriQuest was considered one of the “responsible”
subprime lenders because they didn't do insurance packing. And then of course,
it wasn't four years later that AmeriQuest was the target of new inquiries
because, you know, we’d begun to see what that third model problems were. And
then because [that model] was securitized and “designed to terminate” and
“designed to be sold”, — it's the one that had the seeds of the global meltdown
with it.
And
so that’s the way we focused on the policy and the way we focused on where we
thought the problems were, depending on how much time had elapsed, where we had
time to see what those problems were.
I
was working on the first wave through the early nineties, and then the second
wave up into 2004. And I personally didn't get into the third wave until I went
to CRL in late 2004. [The states had just] started on AmeriQuest before I left
the AG’s office.
Andrew O’Shaughnessy: That is very helpful…. In the context of your
career, then, when did you first start working professionally on matters
related to residential mortgages?
Kathleen Keest: 1984 was when I started and that
was with the first wave.
Andrew O’Shaughnessy: I'm curious about what continuity there was
between these waves of business models and the backward-looking regulation of
those models, or whether they were really distinct.
Kathleen Keest: Well, in some senses there was an
evolution. The evolution I think was driven in part by opportunities of both
market adjustments and – let’s see. The
second wave model at the beginning was all about equity stripping. It was sort
of no-risk lending in the sense that, even when people couldn't afford to pay
off their mortgage, the lender was targeting cash-poor house-rich people, and
then flipping [the loans], taking as much equity out of the property as [they]
could. I think in 1998 or so, [U.S. Senator] Chuck Grassley was head of the
Select Committee on Aging and he held a hearing called “Flipping, Stripping,
and Packing Their Way to Profits,” or something, which was about that. And his
conclusion at the end of it was, “Isn't this a shame? Too bad we can't do
anything about it, because it would involve regulation.” I might be overstating
the case.
But
then, at the same time, what you had with their model was that housing
appreciation was creating a whole lot of opportunity that unmoored itself from
the capacity to pay. People were saying, “take advantage of the appreciation.”
This was still a lot of a refinance market — refinancing your debt. And I guess
it has continuity in the sense that markets evolve to take advantage of
loopholes, and so you can't really think of them as separate. It was an evolution.
It was an evolution created by a lot of macro developments. The whole
securitization thing, I think, was driven in part by a global glut of savings,
looking for a place to park, and mortgage-backed securities would do it.
There was a way in which the second wave and the third wave melded in
terms of business opportunities. For example, because mortgages have to be
recorded, brokers or loan officers at AmeriQuest, their whole model was to have
these deceptively low teaser rates that exploded after two years at a fixed
rate. …. So you would have somebody, a broker or an AmeriQuest-,
Countrywide-type retail officer looking through filings, seeing somebody who's
got a Household loan. Household rates are like 15, 16%. And if you have one of
their home equity second [mortgages], it's 20, 22%. So you get a broker cold
call on you and saying, “Hey, I see you've got a Household loan and I bet
you're paying a really high interest rate on that.” “Um, well yeah.” And he
says, “I can really lower those payments for ya. You know, I can give you a 7%
rate, cut your payments down to blah, blah, blah.” “Well, um, that's great.”
It created a really serious problem [AGs or advocates are] starting to
think about whether or not you can do a UDAP [Unfair & Deceptive Acts &
Practices] approach to it, which is what a [state Attorney General’s] primary
tool is. Because the way the [Federal Trade Commission] started defining
“unfairness” in 1980 involved essentially a cost-benefit analysis is, “did [the
practice cause] substantial harm, not outweighed by benefit?” Well, if you're
somebody that's got a 16% insurance-packed Household loan being offered a 7%
loan to get out of it, is that…? [UDAP]'s not well designed to deal with the
frying pan to the fire kind of [situation] you know. Which is worse? Who knows?
So to the extent that the regulations tried to avoid getting specific and we're
left with UDAP, then that very transition, that very boundary wall between the
second wave and the third wave created its own enforcement problems and offered
real opportunities for brokers to set themselves up as the good guys like
AmeriQuest did in that hearing in 2000.
Andrew O’Shaughnessy: I'd
be remiss … if I didn't get a sense of your narrative encountering mortgage
issues for the first time. So you mentioned 1984. I understand that is towards
the tail end of your time at the Legal Services Corporation [of Iowa]?
Kathleen Keest: Yes, it was. And that was the case that went to the Eighth Circuit
called Besta v. Beneficial Loan Company of Iowa or something like that. And it
was a classic example of the finance companies moving from the small loan
model, taking it into home-secured model. So at the time, Iowa had the Iowa
Consumer Credit Code, and [lenders] couldn't take a security [interest] on real
estate for loans under $2,500. So what Beneficial did was take what could have
been like an $1,800 refinancing, packed it with insurance and the costs of
filing fees to take the loan over that limit. And so basically what they did
was turn what could have been a $2,500 loan into a $5,400 loan or $5,000, and
took a security interest on the home. And that case is reported…. [O]ne of the
volunteer lawyers in Cedar Rapids then had asked me about it…. [T]hat was my
first case.
Then
I went to the National Consumer Law Center and was doing consumer credit stuff.
We were still dealing with the first-wave models. Then I was involved in the
Landbank litigation. For example, they were making loans at 15 to 18%, but with
20 points or so, so that the APRs were really more like 25%. [Landbank was]
operating I think in five states. I think North Carolina they weren't, but I'm
not sure about that. But there was litigation involved in all of that and we
were involved as co-counsel in the Virginia litigation on that one. And what
was kind of interesting to me was that in that they were calling the 15 or 20
points “discount points” and telling people it was to give them a discount on
the rate; kind of like, well yeah, but
when your rate’s 18%, I'm not sure where the discount is. And so we were doing
that through ‘85, ‘86, ‘88, something like that. Then we were involved with the
1994 HOEPA legislation.
I
don't know if you're familiar with the law — with the National Consumer Law
Center and what it does.
Andrew O’Shaughnessy : …[C]ould you elaborate?
Kathleen Keest: Yeah. Well, basically it was a
support center for legal services programs around the country. One of the real
advantages that I had at that point was that I was able to see patterns from
all over the country and seeing what kinds of cases were coming in. So that's
where we were seeing a lot of Associates cases. There was one that ultimately
made, I don't remember whether it was the front page of the Wall Street
Journal or… must have been the Wall Street Journal. In ‘98, I think
‘97 or ‘98 about, a guy named Benny Roberts, who was an older guy in his
seventies, I think, who had bought a freezer meat plan on installments for
$1,200 that got sold to Associates, who then flipped him to the point where by
the time the legal services program in Virginia was trying to defend a
foreclosure, he’d had eleven different loans. Each one of the loans does not
look like it has any violation, but this guy just got screwed. And when I went
through and did a financial analysis of the flow of the money through each of
these [refinancings], it was sort of like he'd gotten actual cash value of
something like $25,000, mostly refinancing his own loans at rates that went
from 12 to 18%, with a few dollars advances, but they now had a $45,000 loan
principal lien on his real estate.
It was kind of like one of those things where, you know, Shakespeare's
“if the law can't deal with this, then the law is an ass.” They really didn't
have any tools in Virginia, so we just kind of laid it out. I think what really got through, what really
saved Benny Roberts was the fact that for some reason I was talking with a
reporter named Jeff Bailey for the Wall Street Journal, who was really
fascinated. And so [the case] ended up appearing on the front page of the Wall
Street Journal and they settled. But
we were seeing that kind of stuff. That was a paragon of that [finance company]
business model. So that's where we were in the late eighties, early nineties.
Andrew O’Shaughnessy: My understanding of the National Consumer Law
Center was that a lot of your work in support of [local legal services
programs] was through publications. Could you talk a little bit about what you
were publishing at the time to help legal aid services working on these sorts
of matters?
Kathleen Keest: I had two volumes, because consumer credit was my field. And so I did
the Truth in Lending volume, or was primarily responsible, not
exclusively. And credit regulation, which in ‘95 we reconceptualized as The
Cost of Credit. And the reason we did that was because since 1980 and the
deregulation movement, which basically got rid of usury ceilings, people had
needed new tools.
With
Truth in Lending, what happened was there was the rescission right,[2] which only applied to
refinancing, but that's where most of the subprime lending was going on back
then. That had kind of been dormant up until this wave of mortgage subprime
lending started in the eighties. And so we ended up focusing a lot in the Truth
in Lending volume on arguments that they could use to rescind these loans.
And then The Cost of Credit. We were also trying to deal with all of the
payday loans that were just beginning. I think I did my first writing on payday
loans in 1988. We were trying to give them tools to deal with overreaching
lending. There's a whole chapter on what we call overreaching, where there's no
[specific] statutory problem, but how to analyze a transaction so that the
fundamental unfairness of it would speak to a judge or a jury. The best
litigators are good storytellers. If you could —like in the Benny Roberts case
— if you could lay out the facts, anybody who's got any sense of fairness or
justice is just going to go, “This ain’t right.”
And
then the other thing we tried to do was say, understand the business model,
break down the transaction. Don't just take a Truth in Lending checklist and
go, “Is this disclosure there? Is this disclosure there? Did they calculate the
APR right?” Look and see the financial implications of this transaction. See
what it does and then try to tell the story.
Then
we went looking for any nonspecific litigation handles that could be used and
making suggestions about that kind of thing. And, again, since we had the
national perspective, we could do that. That first case I worked on, the Besta
case, it went to the Eighth Circuit. That was one where it was sort of almost
unheard of because the Eighth Circuit overruled a trial judge on
unconscionability.[3] And they also said it was
both substantively and procedurally unconscionable, but we're going to base our
ruling just on the procedural unconscionability. But you know, the fact that an
Eighth Circuit, which was a pretty conservative circuit, would do that about
overreaching gave some plausibility to making some of these arguments.
That
was what we were doing in the writing. And then the other thing that we were
doing is explaining developments that we would learn from one case, and then
make it available to everybody else so that they could start looking for things
that might've been overlooked. So that was the benefit. And then the other
benefit of it was if there were decisions that looked sketchily reasoned, we
could point out how they could distinguish those cases. Or if there were facts
that made a difference, to give them a tool to counter bad precedent as well as
giving them access to good precedent.
Andrew O’Shaughnessy: So what made you want to move from that work
back to Iowa?
Kathleen Keest: Primarily it was personal. Iowa is just kind of like a yo-yo. You know…
I got thrown out to the East Coast for
11 years, and then I came back to Iowa for eight years, and then I got thrown
out to Durham for five years. Then I came back to Iowa. Thrown out to DC for
four years and then I came back. It's just the draw of roots, I guess. CLC was
probably my ideal job.
Andrew O’Shaughnessy: What makes you say that?
Kathleen Keest: Because I like to diagnose
problems. I'm a diagnostician, not a treatment specialist. But I could diagnose
the issues and come up with suggestions for dealing with them and then leave
other people to follow through. So that I didn't have to go through dealing
with two years of litigation and dealing with stupid motions for summary
judgment, discovery battles and stuff like that. And it gave me a place to sort
of put my writing. When you're thinking about problems and thinking about what
the solutions could be – having a vehicle to write – it gives you a place to
put it[.]
Andrew O’Shaughnessy: At the AG’s office, my understanding is you
had broad responsibilities for consumer credit protection.
Kathleen Keest: Yeah. We were one of the States that adopted the Uniform Consumer
Credit Code. We were one of only two states that adopted the 1974 version,
which was the more consumer oriented of the [two versions[4]]. And there was a position
there called the Administrator. One of the people in the division of consumer
protection, the head of it was designated as the Administrator, and one of the
people in it was designated as the functional Deputy Administrator. And so [the
latter] was my role. But because there was a… $25,000 loan cap on the
applicability of the [Iowa Consumer Credit Code], some of the finance company
loans would be under that cap. But a lot of the subprime mortgage loans were
over that cap because [loans over $25,00 still fell within the state UDAP
statute.] So I was the one that had [a focus on consumer credit]. Others had
telemarketing or the auto dealers. Those were the two big other issues. So
pretty much the whole spectrum of credit was mine there.
Andrew O’Shaughnessy: At that time, where did residential mortgages
fall in the hierarchy of things you worried about?
Kathleen Keest: In terms of the number of complaints we got in Iowa, it was probably
number two, with auto finance being bigger. Payday was starting to be big. We
had Norwest Financial, which was one of the big subprime lenders, which later
became merged with Wells Fargo. But it was one that was a big issue because I
knew it was a big issue. Iowans tend not to complain, so we didn't get a lot of
complaints, because people A) don't know they're getting screwed and, B) if they
do, it's easy enough for them to think, “I should have been smarter,” even
though these things are so complicated that plenty of people with more
experience, we'll put it that way, get taken.
But
I remember that one of the things that we did was we worked with what has been
a movement that grew out of the NCLC constituent community, the National
Association of Consumer Advocates [NACA], and Cathy Mansfield, who was one of
the few professors at a law school that did consumer stuff from a consumer
standpoint. (Drake [University] is just a few blocks down the street here and
Cathy's a friend of mine.) We worked with NACA, with her on behalf of Drake,
and NCLC to create a home mortgage lending conference here in Des Moines. And I
think that was 1999. And the reason I mention this is that it actually had a
huge payoff.
We were rather surprised that people came from, you know, as far away
as the Puerto Rican legal services program. But we wanted to have it not just
be a legal services community
conference. We wanted to bring in AGs’ offices and state financial
regulators. And so that was, I think, the first time there was interaction over
mortgage lending among the advocacy community, the AGs, and the state financial
regulators together at a conference. And then what happened was, both the
Minnesota AG’s office and the Minnesota financial regulator’s office was
represented at this conference. And so there developed a kind of personal
connection.
A year or so later I got a call from the financial regulator in
Minnesota who had been at that conference saying, “are you hearing complaints
about Household?” And we talked about that a little bit. And so we said, “okay,
Scott, you call your community, I’ll call my AGs community, we’ll call around
and see what we're getting.” And so we had a call then that for the first time
brought together AGs and state regulators. And I think at the outset there were
only eight states. But, for example, in New York, both the financial regulator,
the Department of Financial Services — the department of banking —whatever it's
called, and the New York AG were looking at Household, but they hadn’t been
talking to each other, if I remember correctly. And so that's what ultimately
grew into the multistate Household [investigation]. And that was the first time that, I think,
that AGs and financial regulators worked together on a multistate. The working
group was 20 or 21 states, but ultimately all states signed on.
And
the reason that [coordination is] important is partly because of the amount of
information that's accessible under ordinary circumstances, because regulators
can go in and examine, whereas AGs can’t.
The [AGs] have to get their information first by complaints and then by discovery.
But even more important was the leverage, the tools that [the financial
regulators] had. I mean, AGs mostly just have UDAP, with financial penalties
and maybe some injunctions, whereas the banking regulators can pull their
license. And that's [the lenders’] lifeblood. And so it gave a different
dynamic.
And
then the other thing that happened with that really upped the ante on it was –
and I'm going to give Tom Miller credit for this. He was Iowa’s Attorney
General, still is. He was very interested in this. And we had a very active consumer
Saul Alinsky-type on-the-ground activist group, called the Citizens for
Community Improvement. They were going out and they were talking to the people
who were victims of subprime, predatory
lending and they were bringing people to our office’s attention. And I had been
working with them since their inception back in the mid-seventies, when I was
in a local Legal Aid office here. So they felt pretty comfortable. And then Tom
Miller is totally accessible. There were at least two suicides that were directly
attributable to the pressures of an impending foreclosure. And Tom Miller was
really, I think, affected by this personal thing.
The
first time there was going to be a meeting between the state assistant AGs that
were working on the case and the people from Household, Tom said he was going
to come, which I don’t think [AGs] normally do. And he then called Roy Cooper,
who was the AG [in North Carolina] and had had experience with Associates and
the 1999 [NC] predatory lending law. And then Chris Gregoire, because the state
of Washington was doing a lot, both in the AGs office and because they had a
very active Department of Financial Institutions at the time, and had a big
case against Household. So he told Chris and Roy that he was coming. And then
one of the deputies from the New York [Department of Financial Services] found
out that these AGs were going to be coming, and so she talked to her [boss] —
the Superintendent, a woman named Elizabeth McCaul. And so, from the get-go at
the meetings, there was this really high-profile, high-leverage design to that.
That ended up with what at the time was the largest mortgage settlement ever,
$484 million or something like that.
Andrew O’Shaughnessy: When was that settlement reached?
Kathleen Keest: I believe that was 2002. And at
that point we were starting to see the AmeriQuest problem. That was the next
target. And that was just beginning.
And
that actually kind of began with a whistleblower — a whistleblower about
appraisal fraud within AmeriQuest. And so it began as sort of a narrow issue.
But we'd had somebody who was working inside and called and told us that
basically what they were doing was they were getting appraisals, but if they
didn't – In Iowa we were not having the housing appreciation bubble that they
were [having] in other parts of the [country.] And so basically what was
happening was that when the appraisals were [made], if they didn't support the
loan [that] the loan originator wanted to make, [that appraisal] went into the
wastebasket and [the originator would come] up with other [appraisals]…. This
notion of “made to order” appraisals coming up to support these loans would not
have been necessary in states where there really was a housing bubble.
When
[the whistleblower] called, I think she said she knew of people in Texas and
Colorado and a couple of other states where that was going on. So that's how
the AmeriQuest things started then, with the appraisals. I think it ultimately
grew into a lot of other problems that were uncovered during the course of
investigation.
Andrew O’Shaughnessy: As the inquiry grew beyond the initial
fraudulent appraisals, did you feel like you had the legal tools necessary to
pursue what you were turning up?
Kathleen Keest: That’s where I think the problem
with the UDAP issues come up. But I think it was like February of 2004 or
something like that when AmeriQuest started, and I left the AG’s office in July
of 2004. So somebody else, Patrick Madigan, my successor, took over from then.
But I think the issue with the tools is how adequate UDAP is. And then you also
get into the, you know, what I call the “zeitgeist matters” [factor], because
deception and unfairness can be sort of in the eyes of the beholder.
Andrew O’Shaughnessy: So not long after that, you've been at the
Center for Responsible Lending for a little bit when, in 2006, I think it was,
you all published Losing Ground, which was, would it be fair to characterize it
as a relatively early exhaustive look at the third wave [of predatory business
models]?
Kathleen Keest: [Nods yes.] And this brings up a point that I think is really important to keep in
mind in terms of how the problem was able to get so big before it was noticed.
Regulators and AGs, law enforcement, focus on one actor at a time. You could
look at Household’s foreclosure rates, but you can't quite get the broad
picture. And part of the problem is the data. So access to data was key here.
That data was primarily available to the industry and only the industry. For
example, investment analysts could have
access to Loan Performance [a large proprietary database.] They could look at
the collection of the securities that had started to be sold in the private
market. (Now this is private market mortgage-backed securities, not the GSE’s
[Government Sponsored Entities].[5]) A subscription to that
database was something like a quarter of a million dollars a year. The Fed
might've been able to afford it, but certainly a state department of financial
institutions couldn't do it. Academics couldn't do it. Most nonprofit advocacy
groups certainly couldn't do it. But what happened was that the Center for
Responsible Lending was started out with enough funding to be able to do the
job and do the job right. And then when the hiring was started at CRL, they
brought, not just lawyers, they brought in statisticians and you know,
number-crunchers who were able to able to do [analysis].
It was really because for the first time somebody consumer-oriented,
non-industry-oriented could look at the data from a perspective that was
informed by knowledge of what was happening on the ground. We in the advocacy
community and the AG enforcement community were able to see what was going into
the pipeline and knew what those problems were. But we did not have access to a
broad array of data. And so it was really the fact that CRL could afford that
database and was smart enough to hire people who had the number- crunching
skills to do it and had experience with what was going into those loans to know
what to be looking for.
Up until then, that delinquency data was slice-in-time: how many
foreclosures or serious delinquencies that subprime lenders in each state had
at a given point in time. But with this database, for the first time somebody
not in the industry had the capacity and the desire and the wherewithal to look
at longitudinal performance of these loans. That was kind of the key.
And it is important, though I don't know how many other people will say this,
but what happened next was that Losing Ground came out in December of
2006. [T]hen the next thing that CRL did with the data was look at to see the
racial disparities [in lending], because a lot of people were going or looking
at the credit worthiness and… going, “Well, of course they're paying more
because they're higher risk, you know, what do you expect?”
[It was important enough that they tried to limit the use of data for
public consumption.] I happened to be in the place where the fax machine was
when the fax came in from Loan Performance saying [paraphrasing], “You need to
cease and desist publishing. It's on our data. We have a non-publication
provision in our contract.” Well, what Loan Performance hadn’t realized was
that when they signed the contract with CRL or Self-Help, whoever it was, our
people were smart enough to take [that provision] out at that point. (When
you're talking about trying to sell a quarter-of-a-million-dollar subscription,
[perhaps the sales person thinks] it’s kind of like, “Whatever.”) Loan Performance didn't realize that that
provision was not in ours. But when you think about how much the industry was
trying to protect its data [from scrutiny]….
Anyway, after that, they couldn't cancel our subscription but they could
refuse to renew it.
Andrew O’Shaughnessy: So as these reports were coming out, what was
the reception to your research like?
Kathleen Keest: “Oh, worst case scenario. Oh,
worst case scenario. That'll never happen, that will never happen.” What the
prediction was, was one in five. You know, we're gonna have two million
foreclosures in the next few years, one in five [loans will] collapse. So
partly it was, “Worst case scenario.” Partly it was, “What do you expect? These
are risky borrowers.”
Andrew O’Shaughnessy: Was that the universal reaction? Was there any
variation, were some states more interested?
Kathleen Keest: Well, it wasn't so much the
states because at that point it was more of a state-federal [conflict]. Because
at that point the OCC [U.S. Office of the Comptroller of the Currency] in
particular had gone into high dudgeon to protect their national bank charter
and make it the charter of choice. And so the OCC kind of became a bête noire.
Back
to whole “zeitgeist matters” — the industry had kind of morphed from the “we want
to get rid of the bad apples” to “we believe in deregulation, period” —no matter what the evidence is.
But
then the Fed became interested and we were trying to convince the Fed to make
more use of its UDAP authority. Meanwhile, the OCC was out there [pushing a
deregulatory and preemption agenda]. And the problem with the OCC, which just
regulates national banks, is that there were all of these tagalong preemptions,
so that what they did gave preemptive rights to non-national banks because of
these tagalong, parity things.
Then
you also had to deal with the fact that these third wave models — hybrid ARMs —
[were protected by other federal preemption laws.] The 1980
DIDA [Depositary Institutions Deregulation and Monetary Control] Act had
[preempted state laws and] deregulated interest rates and points, although some
states could opt out of it. (And Iowa was one of the states that opted out of
the 1980 Act.) But then the 1982 [Alternative Mortgage Transaction Parity] Act
had preempted any state laws on “creative” financing. It dealt with the
structure of the loans and features other than interest rates, and that
included adjustable rates. So the states were by [federal] statute prohibited
from dealing with kind of the heart of the matter there. Add to that the
regulatory overreach from the OCC. And so [advocacy] was really kind of
focusing on Congress and the federal regulators.
Andrew O’Shaughnessy: I believe Losing Ground came out in
December 2006. At that point, how long did you all think you had to reach
federal regulators and Congress?
Kathleen Keest: Well, we didn't know, partly because the [housing] market was still in
theory appreciating and partly because we also….
Well,
we knew about securitization. We knew that that was a problem. We knew that
this whole design, the “originate-to-sell, designed-to-terminate, to keep the
pumping-out machine going” [model] was a problem. But when it was all going to
collapse was of course just as much a mystery to us [as anyone.] If we were to
extrapolate from the [finance company] business model, the second to third
refinances is where things started to fall apart. But with these
originate-to-sell kinds of things and with the housing bubble, that wasn't
necessarily going to be predictive because the more the property values went up
and the more you got appraisals to order, that check of market value on loans was
not really gonna operate. So we didn't know.
I'd
also like to say by way of background that the other thing that we — or at
least that I — didn’t know about was this whole thing about the derivatives. I
think U.S. Senator Phil Gramm has not gotten sufficient blame for his role in
this because back in 1999 or 2000, in an omnibus budget reconciliation bill
that was something like 1,800 pages long, passed right before Christmas break,
he got in a provision that said nobody at [either the] state or federal level
could regulate derivatives. Which was all of these collateralized debt
obligations and default swaps and all this other stuff. So everybody is
operating in the dark because of Phil Gramm. That was the context in which Ben
Bernanke said a subprime crisis is going to be limited to the subprime sector
because that was, like I said, a black box to them as well as everybody else.
So we didn't really know.
So
we'd been writing [Losing Ground] through 2005 - 2006. They’d [CRL researchers] been doing the data
analysis through 2005 - 2006. But I think it was in February of 2007 when I
think Household and one other big subprime lender ( – HSBC had bought Household
by that time – ) said they were putting —I don't know, $10 [b]illion or you
know — boatloads of money into a reserve against credit losses. And that was
kind of a first crack. So we didn't know, but in fact, I think the first crack
started just two months later and in August came those hedge fund collapses.
Andrew O’Shaughnessy: In our oral histories, we've heard a number of
different narratives about what caused the financial crisis. And so we make a
habit of asking everyone we speak to what their understanding of that is.
Kathleen Keest: Well, first off, it is not
about getting low- and moderate-income people their first [home purchase] loans
because this thing overwhelmingly started as refinancing loans. A large number
of people who had gotten their homes in the prime market lost them in the
subprime market up through probably 2003, 2004. Anyway, that belies the whole
notion that it was, you know, pushing homeownership beyond its boundaries.
Although
once it started getting into the purchase money market, it was more a problem.
Not so much [pushing first-time home ownership] as a mismatch between – and I
think this was a significant thing – a mismatch between income and
affordability. So for example, in
California in 2005, I think the affordability index statewide was 14%. (The
affordability index is what percentage of people could afford to buy a
median-priced house at [standard prevailing loan] terms.) So the problem
became, I think in part, this mismatch between the value of the asset — the price of the asset — and the fact that
nobody was paying attention to ability to repay. There’s a problem when 86% of the population
of California can't afford a median-price home [there]. And so wage stagnation
and the extreme [economic] inequality is playing into it. It is really starting to play havoc with the
housing market — a real serious part. I mean, a serious part of the [problem]
and nobody's paying attention to it or recognizing it. So that's kind of a
fundamental problem, a fundamental macroeconomic problem.
And to the extent that the refinancing lending and the debt
consolidation — which was a big part of home equity lending [market] — was
people borrowing to try to get out of debt, [those factors are at play,
too.] People kept talking about
[borrowers] “living beyond their means,” but, at some point, it's an income
insufficiency problem. And nobody is trying to deal with it except [by] making
more debt accessible to them, but you can't really borrow your way out of an
income insufficiency problem.
Then,
on top of that, there is this whole zeitgeist of deregulation and, “Nope, don't
interfere with the markets. The markets are self-correcting.” This blind,
almost religious faith in a self-correcting market — those to me are the macro
causes of it. Things flowed from that. It’s this uber capitalism, this “greed is good,” and “we don't want to
regulate,” “people are responsible for their own actions.” And at some point I
said, “Why should every commercial transaction for a low-income person be an
exercise in self-defense?” Because this rugged individualism [means that [consumers must protect themselves from those
who have more experience with all these complex products. There’s often disparity in education,
experience, or degree of cynicism and trust. (Someone described the subprime
problem as largely a matter of misplaced trust.)
And then you had the federal regulators like the OCC bound and
determined not to do anything to make the problem better. And a Congress who at
some point had become wussy. And an industry that looked at any regulation as
the camel's nose under the tent. And then the Fed, which was just gradually
[coming to the conclusion something should be done]. And that was only after
Ben Bernanke and Yellen — Greenspan's just a loss. That's kind of where I think
the problems are.
And then the industry was really good at creating middlemen. This
whole securitization thing. Well, to get back to that…. Between 2005 and 2007,
there were some Republicans, conservatives looking at federal regulation that
was trying to create a low, low bar to preempt all these other state laws. At
that point, Brad Miller and Barney Frank, and – I can't remember whether Barney
was doing it or not – but a couple of Congressman from North Carolina were
trying to create a counter with federal legislation and, from 2005, introduce
something. By 2007, Barney Frank was in there, but I remember the discussions
at that point in 2006, 2007 on this federal bill that the consumers advocates
were trying to do. But the idea [in
Congress] was still very much, “We want to protect the securitization market
because these securitizations” – and again, I'm talking about the private
mortgage backed, not GSEs – “are really important to the economy, and it's
really important to the liquidity of the housing market. And so while we want
to get to the heart of the problem, we don’t want to interfere with the
securitizations.”
And so the issue of assignee liability and whether or not a consumer
who's screwed by an AmeriQuest could raise a claim in defense against
foreclosure against whoever owns that thing later on was a huge issue. And
because of the way those CDOs were structured, even figuring out who the hell
the assignee is, and the legal conceptions for ordinary people who were trained
in the ordinary concept of an assignee back when we went to law school – it was
just so hard. It was so hard to understand, because who the hell owns this note
by the time it's been sliced and diced or whatever. The 2007 discussions on
assignee liability to protect the securitization market was a real contentious
issue. And then after the crash in 2008, when Dodd-Frank came up and Title XIV,
which was the mortgage origination reforms, came up, at that point Congress got
a little bit at that. People in that Congress were a little bit more inclined
because they recognized that securitization was in fact part of the problem and
not a hundred percent something to be
secured [from liability.] So there's limited assignee liability in
Dodd-Frank. But how much we protect the big institutions kind of thing. So
yeah. It’s not easy identifying a single causal factor, but all of those things
come together. And I'm a believer in Complexity theory. So all those things
came together to magnify those negative impacts.
Andrew O’Shaughnessy: What lessons would you want state-level
policymakers to take away from this history?
Kathleen Keest: One, that responsible regulation
is good for everybody, including the industry players. Two, that policy should
be driven by experience and evidence, not by ideology. And then law enforcement
and regulators need the tools.
But this issue of
preemption and a self-correcting market is – to me, that's kind of it. That's
based on a fallacy. "Assume away reality and then get rigorous” just isn't
going to work. And that's kind of what it's based on.
Andrew O’Shaughnessy : What haven’t we talked about, would you like
to mention or be sure to emphasize, if anything?
Kathleen Keest: Well, I think one of the issues
that's going to be really ongoing is disparate impact. I started out practicing
in 1975, which at the time I didn't sort of realize was sort of the apogee of a
consumer movement. And then most of the rest of my career has been watching
through the perigee. I thought 2010 and Dodd-Frank and the [Consumer Financial
Protection Bureau] was going to be the beginning of a resurgence. But boy did I
call that wrong.
But
discriminatory treatment is a lot more prevalent than I think the industry
recognizes. There's a really fascinating study by Ian Ayres on auto sales, but
it translates to this: he found both gender and race bias in negotiated prices
on cars. And he said, “It's not part of our study here to explain this, it's
just to find out whether it exists or not.” But he did offer some suggestions.
He said some of it was animus-driven, but some of it had to do, he thought, more
[with] the salesperson's perceptions of who would be easier marks, who would be
easier to kid. When we did studies on yield spread premiums and the racial
differences on yield spread premiums or mortgage brokers and that kind of
stuff, you found that the legitimate indicia of creditworthiness had some
explanatory [value], but [it did not fully explain the differences]. And so the
notion of the implicit bias or explicit bias comes into play. But that’s all
discriminatory treatment, which is usually very, very hard to prove.
But
during most of my legal career, it was not a question that discriminatory
impact was relevant and actionable. But because discriminatory impact is easier
to prove than discriminatory treatment, this assault on it as the law is just
the wrong direction at a time when – I’ve got to take it back to the “zeitgeist
matters” – when racism is becoming legitimized in some quarters. It was a huge
problem. It's going to be a huger problem. And the whole thing about the
inequality and the refusal to take the inequality of the income distribution is
going to have a huge impact, to get back to the mismatches.
I
don’t know, with the housing trends, what it's going to be like, but until we
start paying attention to the fundamentals, everything else is going to be
nibbling around the edges….
Andrew O’Shaughnessy: Ms. Keest, thank you so much for your time
and your generosity with it.
Kathleen Keest: No problem. It's going to be
important to have a record to counter the ideologically-driven revisionism.
[END OF SESSION]
[1] “Flipping” as used here refers to the serial refinancing
of a customer’s loans, typically with new fees rolled in with each refinance.
[2] 15 U.S.C. Sec. 1635 gives consumers a right to rescind
certain home-secured loans in the event of specified material violations of the
Act.
[3] Unconscionability is a legal doctrine whereby a court can
refuse to enforce a contract because its terms are unfair or oppressive. See
Unconscionability, Blacks’ Law Dictionary (11th ed. 2019).
[4] There were two versions of the Uniform Consumer Credit
Code — 1968 and 1974.
[5] Keest is referring here to Fannie Mae and Freddie
Mac. Lenders could sell so-called
“conforming loans” meeting defined standards to these GSEs. The subprime loans, by contrast, did not
conform to GSE standards, and so went into the private securitization
market.