Held Up in Due Course: Predatory Lending, Securitization, and the Holder in Due Course Doctrine, 35 Creighton L. Rev.

503 (2002)

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Creighton Law Review
April, 2002 Article

HELD UP IN DUE COURSE:
Predatory Lending, Securitization, and the Holder in Due Course Doctrine Kurt Eggert [Fna1]

Copyright © 2002 Creighton University; Kurt Eggert Kurt Eggert, Chapman University School of Law keggert@chapman.edu SSRN Author page: http://ssrn.com/author=85932

Held Up in Due Course: Predatory Lending, Securitization, and the Holder in Due Course Doctrine, 35 Creighton L. Rev. 503 (2002)

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I. II.

INTRODUCTION............................ .............. .............. .............. .............. .............. .............. .... 507 PREDATORY LENDING AND ITS VICTIMS........................... .............. .............. .............. . 511 A. Defining and Measuring Predatory Lending............................. .............. .............. ......... 511 B. The Tools of Predatory Lenders.................... .............. .............. .............. .............. ............ 513

1. Fees and Interest Rates Far Greater than Necessary to Provide a Reasonable, Market-Driven Return Given the Risk of Lending to the Particular Borrower.......................... 514 2. Loans Made with No Reasonable Expectation That the Borrowers Can Repay Them.............. .............. .............. .............. .............. .............. .............. .............. .............. .............. ..... 515 3. "Flipping"..................................... .............. .............. .............. .............. .............. .............. .. 515 4. High Pressure and Misleading Sales and Marketing Techniques ...................... ......... 516 5. "Packing"..................................... .............. .............. .............. .............. .............. .............. ... 517 6. Excessive Prepayment Penalties........................... .............. .............. .............. .............. ... 518 7. Balloon Payments...................................... .............. .............. .............. .............. .............. . 519 C. The Boom, Bust, and Bankruptcy Cycle of Predatory Lenders .................................. .. 522 D. The Diamond Mortgage/A.J. Obie Story: Defrauding Borrowers and Investors Alike.............................. ............................ .............. .............. .............. .............. .............. .............. .... 522 E. The Assignment of Risk of Harm Caused by Predatory Lending .................... ............ 527 III. SECURITIZATION AND THE LAW OF NEGOTIABLE INSTRUMENTS........................ 534 A. The Basics of Securitization: Life in the Tranches................................... .............. .......... 535 B. The Advantages of Securitization, Primarily to Investors and Lenders........................ 545 C. The Downside and Dangers of Securitization, Primarily to Borrowers ..................... 550 D. The "Unbundling" and "Atomization" of the Residential Mortgage Industry............. . 552 E. Mortgage Brokers: Too Often Under-Regulated, Under-Capitalized, and On the Front Line of Residential Lending............................ .............. .............. .............. .............. .............. .......... 552 F. "Tranche Warfare" and How Securitization Reduces Lenders' Discretion in Resolving Borrowers' Difficulties .............................. .............. .............. ............................ .............. .............. .. 560

Held Up in Due Course: Predatory Lending, Securitization, and the Holder in Due Course Doctrine, 35 Creighton L. Rev. 503 (2002)

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G. The Survival of the Holder In Due Course Doctrine in the Age of Securitization....... 566 IV. THE RAPID AND TROUBLING GROWTH OF SUBPRIME LENDING.......................... 571 A. Subprime Lending and Subprime Borrowers...................... .............. .............. .............. . 571 B. The Causes of Subprime Lending's Increase............... .............. .............. .............. .......... 577 C. The Links Between the Rise of Subprime Lending and the Increase in Residential Foreclosures ................... .............. .............. .............. .............. .............. .............. .............. .............. .. 580 V. LEGISLATIVE AND REGULATORY RESPONSES TO PREDATORY LENDING ..........584 A. HOEPA and Its Flaws...................... .............. .............. .............. .............. .............. ........... 584 B. The Growth, Success, and Bankruptcy of First Alliance: a Post-HOEPA Predatory Lender ............................... .............. .............. .............. .............. .............. .............. .............. ............. 592 C. State and Local Efforts to Patch HOEPA.......................... .............. .............. .............. ..... 604 VI. THE CASE FOR ELIMINATING THE HOLDER IN DUE COURSE DOCTRINE FOR ALL NON-COMMERCIAL LOANS................ .............. .............. .............. .............. .............. .............. .. 607 A. The Holder in Due Course Doctrine Is Inefficient Because It Prevents Informed Decision-Making by Borrowers ........................................ .............. .............. ............................ ..... 609 B. The Holder in Due Course Doctrine's Assignment of Risk Encourages Fraud ........... 612 C. The Failure of Effective Loss Reduction Under the Holder In Due Course Doctrine .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. . 614 1. Effective Precaution: Borrowers vs. the Secondary Market ................................. ........ 614 2. Innovation and Loss Reduction............................ .............. .............. .............. .............. ... 618 3. The Unresponsiveness of Borrowers to the Loss Assigned by the Holder in Due Course Doctrine .................... .............. .............. .............. ............................ .............. .............. ........ 619 4. The Uncertainty of Risk Assignment by the Holder In Due Course Doctrine .......... 623 D. Loss Spreading, Loss Magnification, and the Holder in Due Course Rule ................ 625 E. Loss Imposition.................................. .............. .............. .............. .............. .............. .......... 628 F. Holder In Due Course as a Default Rule............................. .............. .............. .............. ... 628 G. Default Rules as Gap-fillers in Standardized Consumer Contracts: The Uniform Code's Defense Against Claims of Unconscionability .................. .............. .............. .............. .............. ... 633

or concentrating.........Held Up in Due Course: Predatory Lending.......... and so had to be stripped off and thrown away in order to install the necessary insulation. leaving thousands of victims who lost an estimated seventy-five million dollars.. because it had been installed without insulation. .. because of the holder in due course doctrine. 35 Creighton L..... Her monthly payment was over $240..... When the financing closed... seeing.. CONCLUSION... Ms.... Newton with United Companies Financial Corp. POTENTIAL METHODS OF ELIMINATING THE HOLDER IN DUE COURSE DOCTRINE FOR NON-COMMERCIAL LOANS ......... which included $3.." [Fn4] ...... THE EFFECT OF ELIMINATING THE HOLDER IN DUE COURSE DOCTRINE ....... was approached by a home improver. ........000 loan from the Diamond Mortgage Corporation.... Newton fell behind on her loan payments... a company that had grown rapidly by securitizing its loans. ..... ...... and the Holder in Due Course Doctrine... plus settlement charges.... A Michigan appellate court held that..... The Moxes were likely shocked to discover that they would still have to pay back the loan or face foreclosure. even though her monthly income was only $898.. [Fn1] A predatory lender's criteria for making a loan: "If you could fog up a mirror.. Newton owed not $9. the Moxes had to pay back $31.... 636 VIII. a 76 year old house-bound stroke victim who had difficulty speaking. 640 ***Page506 When Margaret Newton......... [Fn3] "I've heard of sticking people up with guns... they probably did not realize that they were dealing with a dishonest lender engaging in a massive campaign of theft and fraud..000 that they had never received...... ...... Rev... The siding installed on her house was worthless... Securitization. 638 IX... The home improver arranged financing for Ms. they would lend you money...... Diamond sold the Moxes' loan and then went bankrupt.. 503 (2002) Page 4 VII... ... .." [Fn2] When George and Marjorie Mox signed loan documents for a $31. ........ ... if you had red blood running through your veins.. Diamond never paid off any of the Moxes' senior loans as it had promised nor did it give the Moxes the balance of the proceeds...990. ......050 in points and fees.. Understandably..... United Companies tried to foreclose...990 but $15.... pooling them and selling them on Wall Street.. she agreed to purchase siding for $9... even though they did not receive a dime.500.. Ms...... not with pens.................. ... Instead....

even excluding what may be the greatest damage caused. 503 (2002) Page 5 ***Page507 I. residential foreclosures. [Fn7] In that article. This article is the second of a two part series and is an attempt to understand how predatory lending has become so rampant in the American lending industry. At the center of negotiable instrument law is the holder in due course doctrine. The intent of the maker once had an integral role in the development of negotiable instrument law. the role of intent was stripped out of the law and its place was taken over by the mere formal requirements of the various negotiable instruments acts. [Fn5] Worse yet. and a description of the boom and bust cycle of predatory lenders as they grow quickly. and borrower ignorance. unfair pressure. No longer were the words of negotiability. then disappear. When this currency role of bills of exchange was taken over by bank notes and by legal tender. INTRODUCTION Predatory lending is a scourge of the modern American financial system. Negotiability was cr ucial. as the law developed to track the growing usage of negotiable instruments and the intent of those making them. Rev.S.1 billion annually. and that they by and large intended to create negotiable instruments. threats. The goal of predatory lending is to coerce or trick homeowners into obtaining loans with interest rates or fees higher than the borrowers' credit profiles and the market would justify or loans larger than or different from what the borrowers need. pursuant to the codification of negotiable instrument law. and so have financed the unscrupulous lenders who originate those loans. where that fails. Investors in the secondary market have been able to assign almost all such risk. and the Holder in Due Course Doctrine. want or can afford.Held Up in Due Course: Predatory Lending. which cuts off most . through the holder in due cour se doctrine to the homeowners who are the victims of the predatory lenders' sharp practices. mortgage fraud and unscrupulous lending appears to be increasing. considered sufficient in and of themselves to confer negotiability despite the unlikelihood that the maker of the instrument knew of their power or intended that the instr uments be negotia ble. take advantage of many customers. the common use of negotiable instruments faded and with that use disappeared much of the knowledge of negotiable instrument law. Securitization. In this way. including the use by lenders of the same high pressure and misleading techniques that previously had been the tools in trade of unscrupulous used car dealers and shady home improvers. The specific tools predatory lenders use against borrowers are discussed in Part II. such as "order or bearer" viewed as signs from which the intent of the maker of an instrument could be inferred. the words of negotiability were. I argue that the assignment of risk of the harm caused by predatory lending is a t the heart of the problem. sell their loans on the secondary market. borrowers $9. in that the secondary markets that ha ve financed predatory lenders and profited by them have been too able to avoid the risk of harm created by those lenders. 35 Creighton L. Instead. first contractua lly to the originators of the loans and. I argued that negotiability and its primary effects had once largely been understood by the makers of those instruments. since fewer and fewer understood that these specific words would be viewed as evidence of such intent. [Fn6] Predatory lending is the process of engaging in unfair a nd deceptive lending practices and sales techniques that rely on misrepresentation. ***Page508 The first article in this series was an examination of the development in negotiable instrument law and specifically the holder in due course doctrine. Part II also includes case histories of several predatory lenders. A recent analysis of this problem estimated that it costs U. When negotiable instrument law was codified. to provide liquidity to bills of exchange and so that they could carry on the role of currency in an otherwise cash-starved economy. however. the investors have been able to purchase predatory loans with too little concern about their fairness.

Part IV discusses the rapid and tr oubling rise of subprime lending. discussed in Part III. undue pressure. saddled for up to thirty years with an overpr iced loan. Rev. deception. others refinance. the legal and legislative systems have for the most part merely tried to ameliora te the effects of this fundamental pr oblem with a series of judicial. This doctrine is designed to increase the liquidity of notes and other negotiable instruments. has grown rapidly. securities. that doctrine has. then assign the negotiable instrument to a third party who could claim holder in due course status. borrowers lose. However.Held Up in Due Course: Predatory Lending. paying out additional fees to secure a fairer loan. By providing an ease of transferability and liquidity pr eviously undreamt of. since pur chasers need not worry for the most part that the maker of the note has many defenses thereto. and still others continue making payments. such as notes secured by real property. They find themselves defenseless and burdened by loans with harsh terms. a growing and widespread problem. The doctrine is used to assign the risk of many forms of fra ud. and the Holder in Due Course Doctrine. legislative. securitization has taken over what had been the primary purpose of the holder in due course doctrine. Too much of the subprime market is a product of predatory lending. so that borrowers deal primar ily with under-regulated and often undercapitalized mortgage brokers rather than with traditional finance companies. particularly the atomization of the lending industry. as to the new assignees of the loan. and with it has come an explosive growth in the number of residential foreclosures. I argue for the abolition of the holder in due course in any transaction where it may be used against a . high interest rates. most claims or defenses they may have had to prevent the full collection of the loans. Many of these borrowers lose their homes to foreclosure. often in the secondary market and as part of the securitization process. and thousands upon thousands of homeowners. This new use of the holder in due course doctrine has regained prominence through the development of securitization. which is the process of transforming non-liquid assets. aggressively marketed and too little regulated. And so. been abused by disreputable merchants. securitization has rendered the holder in due course doctrine unnecessary. Upon the lenders' quick assignment of the predatory loans. Action by a federal r egulatory agency finally ended the use of the holder in due course doctrine in these forms of consumer contracts during the 1970s. leaving the buyer liable for the purchase price despite ***Page509 the dishonesty of the merchant. and high fees. and sharp dealings. Rather than address the problem head-on and uniformly prevent homeowners ***Page510 and consumers from unintentionally making negotiable instruments. many of them elderly. By allowing those who sign notes unwittingly to be bound by the holder in due course doctrine. and local attempts to halt predatory lending. are losing their homes or are threatened with foreclosure because they are victims of fraud. Securitization. the holder in due course doctrine has again come to be broadly applied against unwitting makers of negotiable instruments. some more effective than others. These recent patches have thus far been ineffective. Securitization allows interest in residential mortga ges to be sold on Wa ll Street as securities and ha s sped the growth of lending secured by the homes of borrowers and the rapid assignment of those loans to holders in due course. 503 (2002) Page 6 defenses that a maker of a note might have to the note once it is assigned to a holder who takes it without notice of those defenses. 35 Creighton L. throughout most of the twentieth century. state. into a very liquid form. forcing the borrower/mortgagor rather than the purchaser of the note to bear that risk when the original lender is no longer available to be sued. higher pr iced loans that are designed for borrowers with less than prime credit records. These merchants would provide defective goods or services. and administrative patches. obtain a negotiable instrument as payment. Securitization also limits the discretion of the holders of notes and their agents in dealing with financially troubled borrowers to work out new payment plans. Part III also includes a discussion of the harm that securitization has caused to residential borrowers. Part V then concludes with a description of the so-far inadequate federal. now against consumers not of goods or services but of credit itself. Subprime lending.

not only is defining "predatory lending" difficult. These practices are often combined with loan terms that. 503 (2002) Page 7 consumer in Pa rt VI. as well as the parties most likely to suffer from significant secondary effects. PRED ATOR Y LEND ING AN D ITS V ICTIM S A. but that many would suffice. alone or in combination. [Fn8] Daniel S. I believe that abolishing the doctr ine would lead to lower interest rates and fees. finding that none are ideal. they would have to use lower interest rates. Instead. Rev. the loan does not fit the borrower. 35 Creighton L. In essence. manipulating the borrower through aggressive sales tactics. the parties least able to pr event or to insure against that fraud in any sort of meaningful way. An economic analysis of the effects of the holder in due course doctrine demonstrates that it encourages fraud against borrowers and magnifies its harmful effects by assigning the risk of fraud to borrowers. to gain new customers. A traditional law and economics analysis contends that abolishing the holder in due course doctrine would increase interest rates and fees to borrowers because it would make collection from borrowers less certain and more expensive. . are abusive or make the borrower more vulnerable to abusive practices. the holder in due course doctrine protects from risk the securitizers and investors who purchase predatory loans. . . brokers. [Fn10] Even in the course of drafting a more than 100 page report on preda tory lending. as lenders currently use the holder in due course doctrine to protect the purchasers of their loans from claims of misrepr esentation and unfair practices. [Fn9] While this definition has been cited by at least one court in a predatory lending case. calling it a mismatch between the needs and capacity of the borrower . the exact definition seems difficult to pin down in a precise formulation. Were lenders forced to compete without the holder in due course doctrine to protect their sharp practices. rather than misrepresentation and undue pressure. ***Page511 II. [Fn12] ***Page512 Opponents to the further regulation of financial services have seized on this difficulty in . Defining and Measuring Predatory Lending Predatory lending is easier to discuss than it is to define. Conversely. either because the borrower's underlying needs for the loan are not being met or the terms of the loan are so disadvantageous to that particular borrower that there is little likelihood that the borrower has the capability to repay the loan. I examine the various governmental bodies that could best accomplish the abolition of the doctrine for residential borrowers. as a result of the loss. Securitization. and the Holder in Due Course Doctrine. or even home improvement contractors--involves engaging in deception or fraud.Held Up in Due Course: Predatory Lending. practices that are used to obtain above market fees and interest rates for loans. perhaps from fear of providing too limited a definition. [Fn11] Some have gone so far as to argue that. given the vigorous fight likely to be waged by the lending industry. such as foreclosure. Ehrenberg provided a rough definition of predatory lending. but it is a task that should not even be undertaken. or taking unfair advantage of a borrower's lack of understanding about loa n terms. two governmental agencies wor king together could only cobble together the following definition of predatory lending: Predatory lending--whether undertaken by creditors. Parts VII and VIII conclude this article with a discussion of potential methods for eliminating the holder in due course doctrine as well as the probable effects of that elimination. even though they are the very parties best able to close down unscrupulous lenders.

possibly more than 72. [Fn19] This estimate. they are neither negotiated over nor understood by the borrowers." [Fn17] The cost of such foreclosures is hinted at by the fact that. are included. when misused by unprincipled lenders. prepayment penalties on subprime loans. [Fn16] These numbers. More importantly. [Fn13] Just as there is no commonly agreed upon definition of predatory lending. as is common in the subprime market. Securitization. these same practices are often used to strip the equity from the homeowner's property. and the Holder in Due Course Doctrine. due to predatory lending is a report from the Coalition for Responsible Lending entitled Quantifying the Economic Cost of Predatory Lending. 1 billion a year. rough as it is. even excluding foreclosures. excessive up-front fees. are difficult to measure exactly. "may well dwarf other estimates made in this report.Held Up in Due Course: Predatory Lending. These per se improper activities include such actions as misrepresenting the terms of the loans and forging the signatures of borrowers on loan documents. Rev. These terms become the tools of predatory lenders when. The Tools of Predatory Lenders Defining "Predatory lending" is difficult because it encompasses many actions that seem. adjustable ra te mortgages. The first set consists of those activities that are either clearly illegal or unconscionable by their very nature. ***Page514 and when borrowers receive little in return for agreeing to them. Neither the direct financial loss nor the secondary costs. at the end of 1999. since they require a determination of exactly how high a given loan's fees or interest rate can be before they are abusive. [Fn20] The second set of activities that make up predatory lending are those that bedevil the regulators of the lending industry: activities that are legal but. 35 Creighton L. [Fn21] For example. which will be discussed in more detail infra. B.S. on their face. As long as these terms that benefit lenders to the detriment of borrowers are understood by borrowers and negotiated by them. foreclosure. to be indistinguishable from legitimate lending activities. there is also no broad consensus on how widespread a problem predatory lending is. and how much damage it inflicts on American borrowers. [Fn14] Perhaps the first studied effort to determine the amount lost by borrowers in the U. The report does note that the total costs of foreclosur es. and even high interest rates and fees could be used in non-predatory loans. 503 (2002) Page 8 defining "predatory lending" to advocate against new steps to stop such lending. is a good first step toward determining the scope of the problem. or choose an adjustable rate loan to pay an initially lower interest rate. pr edatory lending is costing American families $9. which include the following: .000 families were in or near foreclosure just for the loans of sixteen large subprime***Page513 lenders. even though it admittedly leaves out the costs of one of the primary losses caused by pr edatory lending. [Fn18] The analysis concludes that. there is broad consensus on what tools and tactics are used by predatory lenders. rapid refinancing of existing loans. while difficult to calculate. borrowers can either receive something in return for the loans or decide to forgo the loan. [Fn15] This analysis attempts to quantify the amount of harm caused by predatory lending in the United States by totaling estimates of the costs of the following putatively unfair terms: financed credit insurance. making up less than one half of the subprime market. Pr actices such as balloon payments. the analysis explicitly and intentionally excludes the costs to homeowners and the community of any foreclosures caused by predatory lending. and interest rates higher than the borrowers' credit risk would justify. T hough there is no agreement on how to define predator y lending. Predatory lending can be divided into two sets of activities. cause borrowers to pay interest rates and fees higher than the market and the borrowers' credit rating would justify. such as the homeowners' emotional distress and the effects on the community. [Fn22] In the context of predatory lending. a borrower might choose to pay a higher interest rate in order to pay lower fees.

allows subprime lenders to charge customers both prepayment penalties for the refinanced loans as well as points and fees based on the new loans." as the nearly inevitable foreclosure strips the borrower of whatever equity remains in her house. which charged interest rates of "only" 15%-18%. One assistant manager at a major lender's subsidiary described "blitz nights" at her office. and the Holder in Due Course Doctrine. included fees of 25% to 40%. A lender may flip its own loans or multiple lenders might flip each other's loans for the same borrowers. [Fn32] Subpr ime lenders have targeted both blue-collar workers and customers who are delinquent on their loans for early refinancing. Securitization. [Fn24] In addition to excessive interest rates. [Fn33] 4. though uncommon in others. predatory lenders often force borrowers to pay excessive fees. High Pressure and Misleading Sales and Marketing Techniques Predatory lenders succeed to a great degree because of their aggressive and misleading marketing techniques.000 families a total of $1.S. the purchasers may discover too late that the borrowers have almost no way of making the mortgage payment. which have been estimated to cost 750.8 billion annually. such as the elderly. Some lenders accomplish flipping by requiring their borrowers whose loans become delinquent to refinance the loans in order to bring them curr ent. especially directed at those least able to withstand them. [Fn31] "Flipping. [Fn29] Mortgage brokers who make loans that the borrower cannot repay are able to sell those loans by falsifying the borrower's income or asset documentation to show a higher income or asset level than the borrower actually has. [Fn23] This disparity between the interest rate charged a borrower and the market interest rate given the borrower's risk characteristics is widespr ead among specific classes of borrowers. Loans Made with No Reasonable Expectation That the Borrowers Can Repay Them An especially damaging form of predatory lending is the origination of loans by a lender who has no reasonable expectation that the borrowers can repay them.9 billion a year. and has been estimated to cost U. learning this only when the borrowers stop making payments or contest the loan.Held Up in Due Course: Predatory Lending. minorities who have been traditionally excluded from mainstream financial services. "Flipping" Flipping is the early or frequent refinancing of a loan. Purchasers of notes need to have measures in place to protect themselves from these gambits of dishonest brokers. Fees and Interest Rates Far Greater than Necessary to Provide a Reasona ble. Market-Dr iven Return Given the Risk of Lending to the Par ticular Borrower At the heart of predatory lending is the lender charging fees and interest rates far greater than necessary to provide a reasonable. and the uneducated. 35 Creighton L. These high fees and interest rates seem based more on the costs of aggressive advertising by subprime lenders than on the credit profiles of the borrowers. [Fn25] Many subprime lenders charge fees totaling eight percent of the loan amount or more. market-driven rate of return to the lender given the risk of lending to the particular borrower. leaving the loans with true annual percentage rates of 28%-29%. borrowers $2. so that the loan amount continually rises. [Fn27] ***Page515 2. rather than ***Page516 working out some other plan. Otherwise. 503 (2002) Page 9 1. Rev. even while the homeowner makes her payments. [Fn28] Lending to borrowers who cannot repay the loans is known as "equity stripping." a common practice in the subprime industry. [Fn30] 3. in which the sales staff would . normally with each new set of loan fees financed by the loan. [Fn26] One subprime lender.

the lender or broker may promise that the rates will go down somehow or that the lender will refinance the loan at better terms in the near future. "If someone appeared uneducated.000 reportedly not uncommon. perha ps the product most widely and egregiously packed with loans. [Fn46] In practice. [Fn38] The lender may include these unnecessary products in the loan without giving the borr ower prior notice they will be included and without giving the borrower time at the closing of the loan to notice the extra costs or to object to them. [Fn42] One estimate concludes that packing of credit insurance alone costs American borrowers $2. sorted by age.1 billion annually. fees that are added to the amount the borrower must pay to retire a loan before it reaches full term. so that the loan goes into default and the borrower becomes desperate. such as insurance to pay off credit card debt or to service home appliances. such as single premium credit life insurance. forcing her . inarticulate. prepayment penalties are designed either to trap the borrower. Securitization. covering up crucial terms in the documents so that the borrower does not see them. [Fn35] Once they have found customers. or was particular ly old or young. Lenders a rgue that including prepayment penalties reduces their risks in lending so they can charge borrowers lower interest rates. . which reduce the amount of interest that lenders receive on a particular loan and which are more common after interest rates have dropped. or gender. [Fn39] Or the lender may deceive the borrower regarding the added products by. the more [insurance] coverages I would try to include in the loan. to allow the brokers and lenders to target specific types of potential borrowers. and must accept the loan pr oposed by the broker or lender. Excessive Prepayment Penalties Predatory lenders include large prepayment penalties. asserting that they are included in the loan. leaving the borrower to understand that they are free. was a minority. the lenders profit enormously on all sides of the transaction. for example. the brokers and lenders may blatantly misrepresent the terms of the loan. . or even forge the borrower's signature. is a form of insurance wherein all of the premiums for the life of the policy are pa id up front. The more gullible the customer appeared.Held Up in Due Course: Predatory Lending. "Packing" "Packing" is the practice of forcing or inducing borrowers to use some of their loans' proceeds to pa y for unnecessary or undesired products. so that the lender often cannot lend the money returned to it at an interest rate as high as the prepaying borrower had been paying." [Fn41] Credit insurance packed with loans can be painfully expensive. [Fn34] Brokers and lenders can obtain databases of homeowners. Predatory lenders try to include as many such products as they can. when employed by predatory lenders. claiming the interest rate or payments will be lower than the rates actually turn out to be. 503 (2002) Page 10 blanket the city with misleading phone calls and mail regarding their lending programs. [Fn44] 6. [Fn40] The same assistant manager described above explained. normally from the proceeds of the loan. and the Holder in Due Course Doctrine. [Fn36] ***Page517 5. [Fn43] Because many lar ge subprime lenders sell credit insurance issued by their own subsidiaries and because the insurance ***Page518 proceeds go to the lender if the bor rower ever does make a successful cla im against the credit insurance. with credit premiums costing over 10% of the loan amount and over $10. Or. [Fn37] Single premium credit life insurance. race. [Fn45] and prepayment charges have been standard clauses in residential mortgages since the 1930s. Lenders and brokers have been known to attempt to pressure borrowers to sign documents without reading them. Rev. a broker or lender may attempt to gain an edge over a borrower by advising the borrower to stop making her loan payments. If the borrower refuses to enter into a loan with the high interest rate proposed by the lender or broker. both to increase the amount of the loan (and the lenders' fees that are based on a percentage of the loan amount) and also to obtain profits from selling these overpriced products. 35 Creighton L. These penalties are designed to reduce prepayments. . I would try to include all the coverages [her company] offered.

35 Creighton L. [Fn56] . the holder in due course doctrine eliminates. for example by falsely claiming that the lender would refinance the loan after a year at a much lower ra te. those misrepresentations would constitute a personal defense to the loan. the monthly payments of which would not retire the loan for thirty years. [Fn48] The use of prepayment penalties has escalated dramatically in the subprime market since 1997. especially elderly borrowers on a fixed income. For example. and the consumers a grossly inadequate awareness. and the Holder in Due Course Doctrine. those personal defenses are cut off by the holder in due course doctrine. or insurance products. Lenders realize. [Fn55] Therefore. [Fn47] A typical prepayment penalty might be $5. Similar ly. [Fn52] Loans with balloon payments can appear deceptively attractive to borrowers. loans with balloon payments can also be disastrous for borrowers. prevents effective legal distinction between fair and voluntary balloon payments. or to reward the lender with an unreasonable payoff when an unwitting borrower refinances the loan. on the one hand. however. more than enough to compensate the lender for any costs of early payment of the loan. therefore. since the lender does not need to worry about a longer term rise in interest rates. [Fn54] The predatory aspect of these lending terms also results from information asymmetry. 503 (2002) Page 11 to remain in an inequita ble loan. and on the other hand those that ar e unfair. though many borrowers do not. [Fn51] Often. the fact that lenders have a much greater awareness. Similarly.3 billion annually and to affect 850. the products of fraud. a borrower might have a loan. that borrowers typically repay loans much before the full term of their loans. and foisted on an unwitting borrower. Rev. rapid refinancing. [Fn53] The holder in due course doctrine. as to the purchasers of loans. thus incurring a new round of points and fees. Rather tha n attempting to lock a borrower into remaining in a loan for the long term. [Fn50] 7. since the balloon payment allows the lender to offer low monthly payments. lenders can use lending terms such as prepayment penalties to extract much greater fees from borrowers than borrowers realize they are paying. While balloon payments can be a useful way for some borrowers to lock in a low interest rate. at which time the borrower would have to pay off all of the remaining balance of the loan. but that has a balloon payment due at ten years. of the terms of the lenders' loan products and the legal effect of those terms. [Fn49] and prepayment ***Page519 penalties in the subprime market are estimated to cost American borrowers $2. Securitization. If a mortgage broker made misrepresentations to induce the borrower to obtain a loan with a balloon payment or a high interest rate. Once a bona fide holder holds the note representing the loan. balloon payments force a borrower at a set time to repay all of the remaining balance on a loan rather than continuing to make monthly payments until the entire loan has been repaid. Balloon Payments Balloon payments are in a way the opposite of prepa yment penalties. the borrower would have a defense to a loan where the lender misrepresented the effective interest rate to induce the borrower to ***Page520 refinance a loan that the borr ower had obtained only months earlier.Held Up in Due Course: Predatory Lending. these borrowers were either unaware of the balloon or were given misleading oral assurances that the balloon payments could be easily refinanced. What turns these sometimes benign lending practices into elements of predatory lending are sharp lending practices that would give a borrower a defense to the collection of the loan if the original lender still held the loan.000. any distinction between high rates and fees that result from the market accurately pricing the borrowers' risk versus high rates and fees that mortgage brokers obtained by misrepresentations and deceit. Such borrowers are highly unlikely to be able to pay off a sizeable balloon payment without refinancing the loan. and that lenders will obtain a significant income stream on prepayment penalties alone.000 families.

then. followed in a few years by growing allegations of improprieties. Diamond embarked on a pattern of fraud and. and Bankruptcy Cycle of Predatory Lenders Many predatory lenders have gone through a similar cycle: sudden growth. a securities dealer. Obie & Associates mortgage-backed securities fraud. [Fn63] The purchasers typically claim to be holders in due course. as planned. Securitization. but often slowly. fueled by the predatory loans themselves and stoked by the quick influx of cash provided by the securitization pr ocess. The Boom. have known whether consumers could qualify for prime loans. as well as an explanation of that scor e. a leading credit scoring company begins to provide credit scores to potential borrowers. is that of perhaps the first significant predatory lender to turn to securitization. [Fn58] Some information asymmetry has been caused by the fact that lenders know consumers' credit "scores. [Fn65] Diamond.J. [Fn64] D. Bust. 503 (2002) Page 12 This information asymmetry persists despite the disclosures designed to inform consumers about the exact terms of their loans before they enter into them. while the individual consumer could only guess. The crash typically happens when publicity regarding the lender's methods so frightens the lender's financial backers and loan purchasers that the lender suddenly finds itself without the ability to fund or sell its loans. and A. 35 Creighton L. [Fn61] An unscrupulous lender can take advantage of its knowledge and the consumer's ignorance by misrepresenting the ***Page522 effects of these different packages and trap the borrower into a loan that costs much more than the borr ower's credit r ating would justify. A less than honest broker can mix the TILA disclosures in the formidable stack of paperwork that makes up the loan package and easily convince a borrower not to pay any attention to the very information that could save the homeowner from ***Page521 entering into an improvident loan. by investigations conducted by regulatory agencies. Lenders. delayed regulatory response. The Diamond Mortgage/A. while consumers have largely been in the dark about their own scores.Held Up in Due Course: Predatory Lending. victimized homeowners fighting a pitched battle . Obie Story: Defrauding Borrowers and Investor s Alike An early example of this boom. A large portion of the information asymmetry. as well as an acid test for the holder in due course doctrine's utility in assigning risk of fraud.J. was a mortgage broker that somehow gained control of Obie. leaving its borrowers to contend with the purchasers of their loans over the validity of those loans." which determine what loan rate the borrowers should receive. [Fn59] Better still would be a rule requiring lenders to provide to borrowers the credit score used by the lenders. These allegations are followed. C. perhaps after declaring bankruptcy. This asymmetry may dissipate if. joined by Obie. and the Holder in Due Course Doctrine. though that investigation often produces few timely results other than to publicize the lenders' methods. however. the predatory lender goes out of business. succeeded in defrauding homeowner borrowers and investors alike. is inevita ble given the complexity of the lending process and the multiplicity of options that many borrowers have. formed in 1973. celebrity spokespersons. Diamond/Obie engaged in an extended Ponzi scheme that came to include many of the elements that have since been the hallmarks of securitized predatory lending: high pressure sales. in about 1980. and thus immune to any defenses the borrowers might have as a result of the predatory lenders' illegal or dishonest behavior. bust and bankruptcy cycle. Beginning in the middle or late 1970s. bankruptcy. [Fn62] At that point. Only after several profitable years of predatory lending does the entire structure come crashing down. the infamous Diamond Mortgage ***Page523 Corp. Rev. [Fn57] The federal Truth in Lending Act ("TILA") requires information regarding loans to be disclosed in a way that can be misunderstood by consumers. [Fn60] A borrower faced with various adjustable rate mortgages with different packages of potentia l prepayment penalties and balloon rates would need a sophisticated understanding of interest rate fluctuation and prepayment rates to make a well-informed decision. allegations which the lenders furiously deny.

In about 625 cases. Obie would promise the investors either a whole loan secured by residential pr operty in return for their investment. which were labeled "securities" by Diamond's offering circular. [Fn66] Loan rates were fifteen percent annually or more. and driving investors to banks to withdraw money to invest with Obie. while Diamond employed actor George Hamilton to entice borrowers. 503 (2002) Page 13 with defrauded investors. Barton Greenberg. ("CMI"). [Fn71] Greenberg. Securitization. respectively. whereby the loans were actually funded by investors. and use documents in the loan transaction that were inconsistent a nd confusing as to what amount the borrower would receive. Diamond/Obie obtained signed notes and mortgage deeds and sometimes brokerage fees [Fn75] from potentia l borr owers at the time they applied for mortgages and then recorded a lien against the homeowners property without ever giving the borrower any loan proceeds ***Page525 or paying off senior liens as promised. it would record the mortgage and assign the note and mortgage. borrowers and investors. what the annual percentage rate and finance charges were. without any obligation by the borrowers to pay anything.. [Fn67] Obie employed ***Page524 the actor Lloyd Bridges to solicit investors. such as doctors. 35 Creighton L. Rev. or promise them securities backed by loans secured by such property. would allegedly impose a brokerage or prepaid finance fee at the time of closing. lawyers. [Fn70] Once Diamond had obtained the signed note and mortgage deed for an individual loan. [Fn76] Diamond represented to the borrowers that they would receive the proceeds of the loans if their applications were approved. Diamond/Obie would never give the borrowers a dime. the chairman of Diamond's Board of Directors. At the same time Diamond was seeking borrowers. seeking their retirement funds. Often. and the con artist at the center of the scheme resurfa cing in a new company and a different guise to defr aud anew. Obie marketed to investors both the CMI shares and the mortgage notes. [Fn68] Obie's sales agents employed tactics such as requesting a power of attorney from elderly investors so the sales agents could withdraw money directly from the elderly investors' bank accounts. either to purchase whole individual loans or to buy securities backed by loans. though often Diamond was only engaging in a table funded loan. and judges. a high school drop-out and former bartender and seller of home-improvement programs. what amount was financed. with an initial fee of twenty points. despite their high interest rates and excessive brokerage fees. Diamond. [Fn69] Although the Obie sales agents targeted many elderly and unsophisticated investors. it would immediately sell them to Commerce Mortgage Investments. then increase the amount of the loan to cover the fee. but if they did not receive any money. leaving the borrowers' property encumbered by a mortgage despite never receiving any proceeds from the loan. for example. CMI issued shares denominated "common stock. though it would record a lien purportedly secur ing a sizeable loan. [Fn79] Diamond/Obie also defrauded investors by taking their money. The loans would name Diamond as the lender.Held Up in Due Course: Predatory Lending. they also snared professionals. [Fn74] Diamond/Obie reached a new level of pr edation by veering from misrepresentation and sharp practices into outright theft. [Fn77] Rather than discharging the mortgages. Both Diamond and Obie used celebrity endorsers and high pressure and dishonest sales tactics in soliciting. then either never assigning any note and . The Diamond/Obie scheme was the following: Diamond would solicit borrowers to obtain loans secured by their principal residence. was also the director of CMI." [Fn73] Then. the mortgages would be discharged. [Fn78] Even if Diamond/Obie received a timely cancellation from the borrower under TILA. Obie was searching for investors. Diamond/Obie sold and assigned them to investors. and whether Diamond was acting as a lender or a broker. and the Holder in Due Course Doctrine. a real estate investment trust so closely connected with Diamond that they were located in the same building. was the owner and mastermind behind Diamond/Obie. engaging in high pressur e sales practices to trick the borrowers into entering into the loans. Ltd. [Fn72] After purchasing the note and mortgage deed.

had sued Diamond in 1979 in ***Page526 quo warranto and under the Michigan Consumer Protection Act. Diamond began committing fraud sometime in the mid to late 1970s. and that investors were "sacking" the company.000. [Fn94] Greenberg demonstrated the ease of entry into the mortgage business and the damage that such easy entry causes when. [Fn97] E. "we may very well be subject to a suit which contends that we are a willing participant if not an aider and abettor of a fraud. that despite Greenberg's actions of skimming millions of dollars. it sat on the loans. or assigning the same note to multiple investors.Held Up in Due Course: Predatory Lending. according to published reports. 503 (2002) Page 14 mortga ge deed to them. the Michigan Attorney General also entered into a consent judgment with Diamond. ***Page527 Greenberg joined a firm called First Fidelity Mortgage. Illinois securities officia ls attempted to force Obie to return $15 million in investors' money for its delays in assigning mortgages to investors. [Fn86] Michigan's attorney general. citing the difficulty for and cost to Diamond of producing financial statements. violated state requirements by being unaudited. given the amount of notice they had. alleging usury and violations of Michigan's consumer protection laws.000. finally revoking First Fidelity's license. refusing to close the loan or return the fees (or pay its "bird dogs" their prizes or its loan officers any commissions). and the state regulatory officials. [Fn84] Diamond's attorneys. in August 1986." [Fn95] After his company received the fees. Greenberg worked with Fidelity Mortgage Co. in up front fees from borrowers as "retainer's fees" or "returnable deposits. bureau investigators noted that Diamond appeared to be in grave financial straits. [Fn80] Diamond/Obie ended up owing about 2. but then failed to take any further action or question why the last annual report Obie filed. in August 1994. Diamond still had a sizeable mortgage portfolio when it collapsed. Instead. requiring it to return $7. Instead of closing loans and selling them to one or multiple investors as he had done previously. [Fn89] One internal bureau memo stated that.000. [Fn81] Diamond/Obie's lending and investment arms had been so profitable. for about two years before the regulators caught up with him and ordered First Fidelity Mortgage to cease its mortgage lending. [Fn87] Diamond signed a consent decree with the Michigan Corporation and Securities Bureau in 1981. though. though not enough to cover the investors' losses. and despite the nature of the Ponzi scheme. holding fewer than thirty percent of the mortgages Diamond claimed it held. he again worked as a mortgage broker. within weeks of being released from prison. [Fn82] Searching for deep pockets. [Fn91] For their pa rt. and recommended that Diamond be shut down. Greenberg allegedly obtained his illegal profits by demanding thousands of dollars.000 to investors and assign mortgages to investors more promptly. if the bur eau allowed Diamond to remain in business. In 1983.700 often elderly creditors an estimated $75. [Fn83] George Hamilton. [Fn92] Finally. the investors filed suit against Lloyd Bridges." [Fn90] Bureau investigators noted that the mortgages Diamond supposedly held for investors had a delinquency rate of twenty-six percent and were being used as collateral for bank loans. [Fn85] The inability of regulators in two states to react to the fraud of Obie and Diamond is staggering. Rev. and the Holder in Due Course Doctrine. Diamond/Obie used the money provided by new investors to placate old investors in an immense Ponzi scheme. [Fn93] For his role in the Diamond/Obie fraud. Securitization. 35 Creighton L. whereby Diamond agreed to abide by state and federal loan disclosure requirements. in one case $23.000. Barton Greenberg was sentenced to only six years and eight months to ten years in prison for embezzling $44 million from the investors in Obie and Diamond. the Michigan Attorney General closed Diamond/Obie and charged its principa ls with fraud. The Assignment of Risk of Harm Caused by Predatory Lending The Diamond/Obie fraud caused an agonizing dilemma for the cour ts because it posed two sets of victims . [Fn96] Despite his Diamond/Obie conviction. the state waived its right to audit Diamond. [Fn88] By 1982. Despite his conviction and widespread fame as a dishonest lender. in 1984.

§ 3-305. 503 (2002) Page 15 against each other in a desperate attempt by each to save or recover vital property or money. lack of legal capacity.C. the originators may be contractually obligated to buy back any notes that do not meet the underwriting standards of the purchaser. which include infancy. fraud that caused the obligor to sign the instrument having neither the knowledge of nor a reasonable opportunity to discover of its "character or its essential terms. Leja. (iv) without notice that the instrument contains an unauthor ized signature or has been altered. and (2) the holder took the instrument (i) for value. [Fn98] For example. 35 Creighton L. [Fn104] where an investor had purchased a note even though the homeowner had . The holder in due course doctrine failed miserably at one of the most important requirements for a rule of loss. and the Holder in Due Course Doctrine. straining to find some means of preventing them from having to pay back their loans." or the obligor's discharge in insolvency proceedings. illegality of the transaction if it nullifies the obligation.C. (iii) without notice that the instrument is overdue or ha s been dishonored or that there is an uncured default with respect to payment of another instrument issued as part of the same series.C.C. the Diamond/Obie cases present the most stark test of the method by which the laws governing loans secured by the residences of the borrowers assigns the risk that the homeowner will be the victim of pr edatory lending. There are two primary methods by which such risk is assigned to the various participants in a loan transaction. despite the lack of consideration for them. which defines a holder in due course as the holder of an instrument if: (1) the instrument when issued or negotiated to the holder does not bear such apparent evidence of forgery or alteration or is not otherwise so irregular or incomplete as to call into question its authenticity. [Fn103] The Obie/Diamond debacle is the acid test for the holder in due course doctrine's ability to assign risk of loss in a fair. [Fn99] The second primary method of assigning risk in the mortgage context is through the holder in due course doctrine. In Thomas v. On the other hand. the purchaser ***Page528 could force the originator to buy back the loan.Held Up in Due Course: Predatory Lending. as will be discussed in the context of securitization. and (vi) without notice that any party has a defense or claim in recoupment described in § 3-305(a). since it presents the difficulty of choosing whether the borrowers or purchasers of loans should bear the ultimate loss in the most stark ***Page529 terms. Securitization. which is predictability. the purchasers of notes secured by residences can contract with the originators of such notes to give the purchasers recourse against the originators for any problem loans. duress. and then leave the borrower and the originator to resolve the borrower's claims. At least six published opinions addressed the issue of whether the borrowers or the investors would bear the risk for Diamond/Obie's fraud where the borrowers did not receive the proceeds of the loans purportedly secured by their homes and the loans were sold to the investors. orderly way. less than complete incompetence. often their life savings or their retirement funds. cannot be asserted against a holder in due course. [Fn102] Other defenses that the maker of a note might have against the original beneficiary. (ii) in good faith. In this way. discussed extensively in the first article in this series. On the one hand. [Fn101] A holder in due course takes a negotiable instrument free of many of the defenses that a borrower would have against the original lender. the often elderly investors had paid good money to purchase those mortgages. First of all. [Fn100] This doctrine is currently contained in U. a holder in due course takes the instrument subject to the so-called real defenses. In this way. homeowners were faced with liens encumbering their homes even though they had never received any proceeds from the underlying loans. the courts found for the borrowers. In other cases. if a borrower could convince the purchaser of a note that it is the product of fraud or deceptive practices. (v) without notice of any claim to the instrument described in § 3-306. Rev. such as fraud or misrepresentation that did not pr event the maker of the note from learning its essential terms. The cases were decided utterly inconsistently. Pursuant to U. with some courts finding that the investors were holders in due course and so entitled to collect on the notes. or undue influence. § 3-302.

[Fn116] Unsurprisingly. and had learned of Diamond/Obie's financial difficulties and impending bankruptcy before she was assigned the note and mortgage. The court concluded that the borrowers' motion for summary disposition. since the plaintiff was not a bona fide purchaser for value. notice of their right to cancel. Instead. [Fn105] In Stone v. though. the court in Mox appears to assert that the mortgage's non-negotiability is a reason to conclude that the investors were holders in due course despite their knowledge that the property secured by the loan was still subject to a previous encumbrance. the borrowers were free to rescind. [Fn118] the court found that where the borrowers had each received one. finding that the investors were holders in due course. the loan had never been consummated because the borrowers had never received the proceeds of the loan. [Fn115] the trial court held that. had complained to Diamond/Obie. given the self. [Fn117] In Elsner v. [Fn112] the trial court granted. and the Holder in Due Course Doctrine. [Fn106] the court held that the holder in due course doctrine did not apply to the mortgage securing the note that had been sold to an investor. The court in Mox also noted that the mortgage instr ument is not negotiable. finding that because the homeowner never received the proceeds of the loan. [Fn109] after the trial cour t quieted title to the borrowers' property and voided the mortgage held by the investor. Securitization. State Mortgage. but did not use that as a means of freeing the borrowers from the mortgage. Jordan. the investors' motion for summary judgment against the borrowers' claims of lack of consideration. that the mortgage was invalid. though for completely different reasons. although Diamond had never disbursed the loan proceeds to the bor rowers. [Fn108] In Thomas v. constituted a notice of rescission. T he trial court held. because it alleged the borrowers had a right to rescind under TILA. once Diamond had assigned the loan to the investors. [Fn113] The court in Mox distinguished Stone as being based on lack of TILA disclosures. because . [Fn107] The court further found that because Diamond had not delivered a disclosure of the borrowers' right to rescind the transaction. while asserting that it would not have to follow the federal court's discussion regarding the holder in due course doctrine in Stone. the debt was still valid because the investors were holders in due course. the trial cour t found the homeowner's mortgage and promissory note "null and void for lack of consideration. the court of appeal reversed. After the borrowers rescinded. as the court had done in Stone. finding that the investor was a holder in due course ***Page530 of the mortgage despite facts calling the loan into question. the borrowers' right to rescind continued. the borrowers retained their right to ca ncel because each had not received two such notices. both parties appealed. Albrecht." The appellate court affirmed. and the court of appeal affirmed. [Fn114] In Franck v. preserving their rescission rights under TILA. While the rescission sent by the borrowers to Diamond was invalid due to Diamond's bankruptcy. since the TILA rights to rescission were not cut off by assignment to a holder in due course. based on not receiving the proceeds of the loan. 35 Creighton L. even though the loan had been assigned to a holder in due course. but only one. and so plaintiff retained his right to rescind under TILA. Mehlberg. Rev. 503 (2002) Page 16 never received the loan proceeds. [Fn110] The investor had stopped receiving interest on her investment. despite their knowledge that the senior loans that were to have been paid off by the loan at issue were not paid off by Diamond.contradictory decision.Held Up in Due Course: Predatory Lending. The court also concluded that the investor had never become a holder in due course because of irregularities in the documentation delivered by Diamond and Diamond's dishonest and unprofessional actions toward the investor. ***Page531 which was valid despite the investor's status as a holder in due course. the borrowers were not obligated under the loan. because the mortgage was not payable to order or bearer and so was not a negotiable instrument. the loan was never consummated. based on Diamond's fraud and lack of consideration. The court held that even though the borrowers were husband and wife. The appellate court held that even though the borrowers had never pled TILA rescission as an affirmative defense. [Fn111] In Mox v. Bedenfield.

C. on both the tria l and appellate level. Some courts strained to find the slightest reason to prevent the borrowers from losing their homes. Securitization. [Fn127] ***Page533 Jordon and Warren note that." but also "observance of reasonable commercial standar ds of fair dealing. when applied to notes secured by residential property and combined with TILA. in that they altered the definition of good faith required for one to be a holder in due course. stating. the new standard is not a pure objective standard but requires only "observance of reasonable commercial standards of fair dealing. it also maintained a somewhat more objective standard toward notice.C. while the U. [Fn126] This relatively objective standard toward notice dampened the effect of the subjective standard toward good faith. Faced with nearly identical circumstances. since a holder cannot claim a "pure heart and empty head" if she had reason to know of the facts that would prevent holder in due course status. [Fn121] In the course of revising Article 3. which contains the holder in due course doctrine. the holder in due course doctrine seems so difficult to understa nd that even the courts themselves. clearing houses and the Federa l Reserve Board. had a subjective standard regarding good faith for the holder in due course. making variable rate notes potentially ***Page532 negotiable. Worse yet. they each had to receive two copies of the notice of right to cancel to begin the three day cooling off period. misunderstand or misapply the doctrine on a regula r basis. the distinction between the subjective and objective standards of good faith is rarely significant." [Fn124] While the dr afters no doubt thought this change might have a noticeable effect on the holder in due course doctrine. ignored damaging evidence that the investors knew or should have known Diamond and the loans that were assigned to them were suspect." a lesser standard. she had reason to know the fact. In those cases. and so should have been denied holder in due course status.C.Held Up in Due Course: Predatory Lending.." [Fn123] This change. the courts ruled for either the borrowers or investors. made apparently so that Article 3 and Article 4 would be more harmonious. searching for any justification for allowing the borrowers to rescind. White and Summers state: . and the Holder in Due Course Doctrine. [Fn120] The only significant change made in the course of revising Article 3 was one that aided lenders.C. in order to protect the investors." [Fn128] Hawkland and Lawrence are even more emphatic. Article 3 of the U. making it even harder for any par ty to plan its decisions ba sed on this rule. with little or no way for any party to the tra nsaction to predict the outcome. but rather a much smaller change from a subjective standard to a somewhat less subjective but not fully objective standard. The previous standard had been one of "honesty in fact. [Fn119] These cases demonstrate that the holder in due course doctrine. in a drafting process dominated by representatives of banks. Two sets of the most noted commentators on the UCC agree that this is not a move from a subjective standard to a fully objective standard. the drafters expanded the good faith standard to require not only "honesty in fact. was revised in 1990. the drafters made a substantive change in the holder in due course doctrine. because of this objective nature of notice. the issue of whether good faith is subjective or objective seems academic. 35 Creighton L. it seems unlikely to be significant in the curr ent home loan industry. has been a hopelessly ineffective and almost irrational method to allocate the risk of loss. 503 (2002) Page 17 they both had an ownership interest in the property. First of all. [Fn122] In revising Article 3." [Fn129] Furthermore. Rev. a holder will lack good faith because he has notice of a claim or defense. Other courts. "Most cases probably involve situations in which the facts relevant to the issue of good faith are the same facts giving rise to the notice of a defense or cla im." also known as the "pure heart and empty head" defense. is "concerned with the fairness of conduct rather than the care with which an act is performed. [Fn125] A person was held to have notice of a defect in the note that would deny her holder in due course status when from all of the facts and circumstances known to her. "In the vast majority of cases.

" The issue is one of "unfair ness" not of "negligence. and the Holder in Due Course Doctrine. But if a court instructs the jury using the words of the statute. SECURITIZATION AND THE LAW OF NEGOTIABLE INSTRUMENTS While some have claimed that the FTC Holder in Due Course Rule and other changes have effectively eliminated the importance or effects of negotiability. investors have been able to channel huge sums of money into the lending industry. in Jordon. jury instructions will have to be somewhat different. the method of . the test remains a subjective one.Held Up in Due Course: Predatory Lending. the facts giving rise to the issue of good faith and the facts giving rise to notice of a claim or defense will be almost universally identical and so. In such instances. now new secondary markets for loans cause the near instantaneous creation of a multitude of new holders of loans claiming status as bona fide purchasers. purchasing the beneficial interest in the loans produced. it would be difficult to prove that the holders of the notes violated reasonable commercial standards of fair dealing even when the passive entities do inadvertently acquire loans that are the fruit of fra ud and deception. Wa rren and Walt's formulation. preventing the holder in due course doctrine from causing harm by ensuring that few new holders ever received ***Page535 the loans. III. Chief among the changes in these secondary markets is the process of securitization of loans that has come to dominate the residential mortgage industry. Through securitization. [Fn131] This distinction is even more often purely academic given the widespread sale of mortgages in the secondary market and their sale to investors through the process of securitization. the detrimental effects of negotiability. Rev. good faith does not require general conformity to "reasonable commercial standards. Where loans once sat mostly undistur bed in the portfolios of their lenders. Clearly. The extent to which the new good faith standard will affect the outcome of cases is difficult to determine. Thus. While they have often benefited from the high interest loans produced by predatory lenders. At the same time that it is vastly increasing the numbers of holders in due course of notes secured by the borrowers residences. A. securitization has made it far easier for the purchasers of predatory loans to claim holder in due course status despite the revision of Article 3's definition of good faith. [Fn132] instead. it is doubtful that the jury members will ***Page534 see any distinction between the prior standard and the new one. have alighted in the area of home equity loans secured by residential pr operty. the creation of which is normally supervised by a team of underwriters and credit-rating agencies. [Fn130] Hart and Willier are more emphatic: It appears clear that the drafters did not intend to impose any duty to act carefully in taking the instrument." but only to "reasonable commercial standards of fa ir dealing. driven from their traditional home in consumer purchase contracts. the change in the good faith standard was "academic" and with little real world effect in securitized mortgages. 35 Creighton L. these investors have been too protected from bearing the risk of loss caused by the predatory nature of those loans. which will be discussed in the next section. Securitization. The Basics of Securitization: Life in the T ranches The effect of the holder in due course doctrine on homeowner borrowers and the assignment of risk of deceptive loan practices has been fundamentally changed by the process of securitization. it is going only so far. Because the holders of securitized notes are passive entities. 503 (2002) Page 18 So beware. Therefore. specia l business entities designed to hold loan pools and highly unlikely to have any information regarding the underlying loan or the originating lender other than that contained in the disclosures and documents accompanying the note. notes are typically held by passive." If the Code is tilting back toward an objective standard.

four family homes were securitized. or the Federal Housing Administration. Securitization has been defined. [Fn146] The growing importance of securitization can be seen in the expansion of Article 9 of the U. the securitization process maximizes the liquidity of the assets. and Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Cor poration). higher cost. [Fn140] This increase in value to the purchaser potentially allows the seller of the securities to offer a lower yield to sell the security. and private title and mortgage insurance companies sold certificates secured by mortgage pools in the 1920s. blazed the trail for securitization. to include sales transactions that had not previously been governed by it. by the development of new products caused by the . Colletta. because they trade on an open market and do not requir e the paperwor k used to transfer the underlying illiquid asset. a process that increases the liquidity of an asset increases the value of the asset to its current holder. since their implicit guarantee of financial security made some of the securities they issued seem almost risk-free. giving investors confidence in the pricing of securities not backed by the government or a government-sponsored enterprise. facilitating the sale and transfer of notes.Held Up in Due Course: Predatory Lending. [Fn144] These GSEs have since been joined by the Student Loan Marketing Association (Sallie Mae). [Fn142] the ***Page537 modern use of securitization began with the issuance in 1970 of the fir st publicly traded mortgage backed security by the Government National Mortgage Association (commonly called Ginnie Mae). securitization has taken over what had been the central purpose of the holder in due course doctrine. Others have defined securitization even more broadly to include the substitution of securities for loans and loan participations. Securitization. this emphasis on the investment by capital markets is important beca use it drives much of the argument about why securitization is efficient and provides access to less expensive sources of capital. [Fn145] The private sector's ability to securitize separately from GSEs increased dramatically after 1975. the source of capital for mortgage funding has been transferred from the sa vings industry. which used deposits to fund loans. only twenty-three percent of the loans secured by mortgages on one-to. and the Holder in Due Course Doctrine. [Fn148] By the end of 1998's first qua rter. to aid in their securitization." [Fn134] In terms of the residential mortgage ***Page536 industry. when rating organizations began rating the securities produced by securitization. [Fn138] By providing great liquidity to notes. then selling securities that are backed by those assets. which securitizes mortgages guaranteed by the Veterans Administr ation. fifty-two percent of the total outstanding balance of such loans was securitized." [Fn133] Others have defined it as "the substitution of more efficient public capital markets for less efficient. and then selling security interests in that pool of mortgages.C. and by creating sta ndardized. such as Ginnie Mae. ratable. and easily tradeable secur ities from the assets. 35 Creighton L. Through securitization. which securitizes student loans. [Fn143] Government sponsored entities (GSEs). financial intermediaries in the funding of debt instruments. Rev. by an author who noted that there was no uniform definition for the term. to the capital markets and the portfolios of institutional investors. These securities. which securitize high quality residential mortgages. In 1984. securitization is the pr ocess of aggregating a large number of notes secured by deeds of trust in what is called a mortgage pool.C. so that the assets are legally completely independent from their former owner and free of any bankruptcy or liability risks of the former owner. 503 (2002) Page 19 aggregating a large number of illiquid assets. the Farm Home Administration. [Fn147] ***Page538 Securitization of residential loans has grown at a staggering pace. [Fn135] As we shall see. Shenker and Anthony J. [Fn141] While the history of mortgage-backed bonds stretches back into the nineteenth century. as "the transformation of an illiquid asset into tradeable security with a secondary market. are themselves highly liquid and easy to tr ade. such as notes secured by deeds of trust. [Fn137] By limiting the risk facing investors in the asset pools to those inherent in the assets themselves. [Fn149] The dramatic increase in securitization has been fueled in part by the support that the federal government and the GSEs have provided. [Fn139] As noted by Joseph C. in one large pool. [Fn136] At the center of the process of securitization is the isolation of a specific group of assets from the organization that owned them.

[Fn160] If interest rates drop. the securities are typically rated by a national. limited partnerships. This lender quickly sells the loan to a different financial entity. while swelling the returns of the principal. meaning they depend on the assets or credit of the originator. from a multitude of lenders. such as providing additional assets to the securitization pool. or any number in between. or external. 35 Creighton L. [Fn156] SPVs can be trusts. Mortgage brokers may originate the loans in their own names in three ways: (1) by using "table funding" provided by the pre-arranged buyer of the loan. [Fn152] Alternatively. [Fn161] The pool of mortgages can be cut into much more complex strips of mortgages. [Fn153] The loans in the pool may all come from one lender. [Fn150] A typical securitization of a loan secured by a residence might proceed as follows. and a second group to represent the repayment of principal on those same loans (principal-only strips). [Fn164] Because the rating need only be done once for all investors rather than separately and redundantly by each investor. [Fn151] (2) by access to a warehouse line of credit. shrinking the income of the holders of interest-only strips. perhaps. [Fn157] In fact." which is French for "strips. 503 (2002) Page 20 competitive jousting of such players as banks. the prepa yment rate of the loans in the pool normally increases. thrifts. and in return the seller receives the securities issued by the SPV. Securitization. There are a multitude ***Page540 of ways in which these securities can be packaged. the mortgage broker may close the loan in the name of the lender providing the money. the rating process efficiently allows the market to determine the value of the investment and hence the return the investors will demand for purchasing securities backed by the assets to be securitized. or (3) by supplying the broker's own funds. [Fn165] The credit quality of the different tranches of securities can be improved by various techniques of credit enhancement that reduce the ***Page541 risk of loss to the purchasers of the securities. "[a]sset securitization has become one of the most important commercial uses of the trust. The borrower negotiates with a mortgage broker for the terms of the loan. straightforward (as straightforward. involving the credit or assets of a third . which pools the loan together with a host of other loans in a mortgage pool. as anything is in the new world of securitization) division of ownership rights in the pooled loans is for one group of securities to represent the interest that will be paid on the loans (interest-only strips). [Fn159] The securities that the SPV transfers to the seller are carefully packaged to maximize their appeal to purchasers. Credit enhancements can be either internal." [Fn163] To convince potential investors of the value of the securities. or more specialized business entities. unless the home mortgages are backed either by the U. [Fn155] This entity (known as the "seller" because it will sell the securities that result from the securitization process) then transfers the loans to a special purpose vehicle (an "SPV"). and by the openness shown to securitization by the banking industry and securities regulators. " [Fn158] even though the set of fiduciary duties that trust law would normally impose are by and large replaced by the trust agreement's minutely detailed provisions.only strips. or classes of securities. [Fn154] ***Page539 The assignee of the loans then transfers them to another entity. since there will be fewer loans to pa y interest. or "strips. as they receive the payments on principal years before the payments might have been expected. independent credit-rating agency.Held Up in Due Course: Predatory Lending. typically a limited liability company or wholly owned corporate subsidiary. though a trust is considered the most common. are called "tranches. the broker typically almost immediately transfers the loan to a lender.S. Whether the broker closes the loan in his or her own name or in the name of the lender. Rev. at least in the eyes of the market. and the Holder in Due Course Doctrine. which effectively. as different aspects. corporations." of the loans are divided up and sold separately as securities. government or by a government-sponsored entity. A relatively simple. depending on what the creator of the SPV thinks may be most easily sold. and Wall Street firms. [Fn162] The strips. a business entity that has the sole purpose of holding the pool of mortgages. guarantee their value.

the trustee is legally at the helm. [Fn176] The transfer to the special purpose trust must constitute a true sale. [Fn187] . as a credit enhancement. given the effect it may have on the creditors of the originators. sets specific requirements of loss probability for the loans. insurance companies. 35 Creighton L. The collection and distribution of the payments of principal and interest are made by servicers. [Fn181] The SPV itself does not directly collect payments from the homeowners whose notes and deeds of trust are held by the SPV. together with the rating agency. and private individuals. such as an insurer or a bank issuing a letter of credit. since most SPVs are trusts. on detailed representations by the originators of the loans. Rev. servicing rights are often sold to firms that specialize in servicing. [Fn183] Now. the loan pool's ratings. in the poetic language of the securitization literature. they can be sold to investors by the seller. examines the loans assembled in the pool. forcing the originator to act as a shock absorber for the rest of the investors. [Fn168] Credit enhancements can be so effective that they allow even delinquent and foreclosed loans to be securitized. [Fn179] This bankruptcy remoteness is becoming increasingly controversial. [Fn167] Or. the servicer typically is in charge of collection efforts. companies who specialize in this collection and distribution of income and principal from pools of loans. other institutional investors. [Fn182] Originally. r eturning them to the originator. [Fn186] However. [Fn177] The true sale also acts to separate the assets ***Page543 from any potential bankruptcy (to confer. [Fn185] The servicer is employed by the SPV and. "bankruptcy remoteness") or other risk associated with the original lender or pooler of the loans. the inclusion of which would cause a breach of the originator's ***Page542 representations. [Fn166] One common credit enhancement is mortga ge insur ance. however. The servicing of loans provided. [Fn180] The investors typically ar e completely passive once they have had the opportunity to review and approve the offering documents. [Fn170] The intermediaries who pool mortgages. [Fn172] Therefore. [Fn171] Most pooling agreements give the intermediaries the right to force an originator to take back any loan that did not actually qualify for the loan pool. [Fn173] Once the securities are rated. [Fn174] This sale is typically accomplished by private placements or by public offerings. the servicer was often the same financial institution that either originated the loans in the pool or that obtained them from the originator and pooled the loans. [Fn169] Working with the seller to package the loan pool and its resulting securities is an underwriter. however. with each loan in the mortga ge pool insured up to a certain per centage of its value. Instead. a separate income stream for the originators or poolers of loans. with rating agencies beginning to recognize their expertise and to pr ovide ratings for servicers. have been reluctant to undertake any significant diligence in their own examination of the loans or the borrowers and instead rely. and discards loans that do not meet the risk standards set for the pool. [Fn175] The buyers may include mutual and pension funds. which. in this way. the originator can retain an interest in the tranche that will first absorb any defaults in the mortgage pool. 503 (2002) Page 21 party.Held Up in Due Course: Predatory Lending. Nor do the investors take an active hand in monitoring the SPV. the offering materials set out the ***Page544 method of servicing the mortgages and distributing payments to the investors. and the Holder in Due Course Doctrine. so that the party transferring the assets reduces its potential liability on the loans and exchanges the fairly illiquid loans for much more liquid cash. [Fn178] The trust is considered the business form most likely to preserve bankruptcy remoteness. [Fn184] Servicing specialization has increased so much that there are now servicers that specialize in subprime servicing or in servicing distressed loans. directing the activities of the SPV. for the most part. and any third party guarantees and have purchased the securities. the originator of the loans may be forced to take back a loan if the borrower defaults. and an underwriter is involved in all public offerings and most private placements. Securitization.

they save the monitoring costs they would have had to spend in the absence of securitization. Whether or not a foreclosure results in a net cost to the SPV depends on the amount of equity ***Page545 securing the loan being foreclosed. [Fn196] This quick churning of loan principal allows even an institution without a great amount of fixed capital to make a huge amount of loans. companies with severe financial problems and abysmal credit ratings can still create bonds carrying investment grade ratings. On the other hand. the loan is secured by a house worth $120. permitting an originator to raise funds . the investors would make $50. [Fn194] An advantage of securitization to the originator of loans is its extreme usefulness as a leveraging tool. a local lender may sell many of the loans it originates in order to keep itself from being too greatly endangered by a local slowdown of the economy. [Fn189] Therefore. the value of the mortgage pool declines. [Fn193] Because investors in the securities created should not need to monitor the bankruptcy risk of the originator . [Fn197] As discussed in section III(B) infra. assuming that the securitization process has succeeded in divorcing the pools of mortgages from all risks caused by or associated with the originators or poolers of the loan. The primary advantage of securitization is the access securitization gives to public markets and private institutional***Page546 funding. early repayment and. For example. "Securitization is most valuable when the cost of funds. reflected in the interest rate that is necessary to entice investors to purchase the SPV's securities. if the remaining balance of the loan is $60. Securitization also has certain accounting advanta ges. which can be sizeable. [Fn198] ***Page547 Lenders employ securitization to diversify risk. If the loan had a high loan-to-value ratio (LTV). a lending institution can receive payment for those loans quickly rather tha n waiting up to thirty years for repayment. or stops making payments. the lender could foreclose on the property. and then seek a deficiency judgment against the borrower for the amount remaining on the loan.000. disreputable companies that otherwise would have difficulty funding a large number of loans. A more rapid change occurs when a homeowner either pays off the loan. The Advantages of Securitization. The lender can use this infusion of capital to make a new round of loans. since the holder of the loan is often the sole bidder during the foreclosure sale and typica lly bids only the amount of the outstanding balance on the loan. to a lesser extent. [Fn188] In some states. Securitization." [Fn192] Through the securitization process. Rev. the investors could actually make money on the foreclosure process. and the Holder in Due Course Doctrine. 503 (2002) Page 22 As the homeowners gradually pay down their notes by making their monthly payments. lending in a year much more money than it has.000. [Fn191] As Steven Schwarcz has noted. with the cost of capital available in these markets lower than that of traditional sources.Held Up in Due Course: Predatory Lending. is less than the cost of the originator's other. purchase the property at an unreasonably low price that does not even pay off the lender's loan. and the costs of foreclosure are $10. [Fn195] By almost immediately securitizing its loans.000. perhaps because of a decline in the value of the property. the highest rating. 35 Creighton L.000 by foreclosing on the loan and buying the house for the amount of the loan. can consume the remaining equity and even ca use a loss to the SPV and thus to the investors. such as bank loans. if the amount of the loan is far less than the value of the property securing it. [Fn190] B. Despite this possibility of profits from foreclosures. this ability to leverage is particularly useful to smaller. direct sources of funding. by transferring valuable assets to an SPV that is effectively remote from the originator. forcing the servicer to begin foreclosure proceedings. normally through refinancing it. a large loan given the value of the property secur ing the loan. then the costs of the foreclosure process. Primarily to Investors and Lenders The advantages of the securitization process to loan originators have been widely discussed. foreclosure are the two greatest risks facing investors in securities backed by pools of mortgages.

past performance of other pools may be no indication of the likely profit to be obtained by investing in a new securitization. rather than the other way around. securitization allows investors to reduce their information costs by pooling the acquisition of information in the form of a single rating regarding the security of the pool. [Fn208] These forms of recourse for the most part require the continued existence of a relatively solvent seller. for example. of course. trustees. As noted in section II(E). The first method is the use of various contractual forms of recourse between the originator or seller of the loan and the entity that purchases them in the securitiza tion process designed to protect the buyers of the loan at the expense of the sellers. and the Holder in Due Course Doctrine. [Fn204] Investors forced to rely on rating agencies. [Fn206] Investors in mortga ge backed securities should also be wary of the potential for securities fraud. diversification and income tastes of the investors. [Fn205] Rating organizations have regularly upgraded or downgraded the ratings they have assigned to mortgage pools as the repayment and default rates have differed from expected. Securitization. pools can be structured in so many different ways that. originators. cause them to lose their entire investment. Or the buyer may conclude that it would be easier to foreclose against the borr ower and rely on the holder in due course doctrine than it would be to force the seller to take back a problematic loan. and more complica ted schemes involving subordinated***Page549 interests or excess servicing fees. then the loan buyers must depend on their second line of defense. or underwriters may suffer if those third parties' abilities to estimate the likely returns of the securities were also overwhelmed by the complexity of the securitization structure. [Fn202] As previously noted. Instead. a single loan pool contains a large number of loans from one originator. Where the originator of the loan has gone bankrupt or otherwise disappeared. 503 (2002) Page 23 without borrowing and having to report a liability on its balance sheet.Held Up in Due Course: Predatory Lending. [Fn200] Securitization has also benefited investors by giving them a rich banquet of new and varied investment possibilities. A buyer may choose to rely on the holder in due course doctrine even where the loan seller is still in existence. [Fn209] Secur itization by government sponsored entities does seem to be positively correlated with lower interest rates for the borrowers with the best credit whose loans are sold to GSEs. [Fn199] as well as allowing banks to reduce the amount of capital they need to hold by reducing the amount of their outstanding loans. 35 Creighton L. the seller of the loans may make representations or warranties that. structured by the poolers of the assets to appeal to the different risk. they have argued that. so that forcing the originator to buy back all of the problematic loans could force the originator into insolvency. [Fn201] The anonymity of mortgage-backed securities may appeal to some investors. Rev. falling interest rates may lead to increased securitization. at a stroke. Other contractual forms of recourse are those explicitly requiring the seller of loans to make cash payments to buyers or to repurchase the loans in the event of borrower default. [Fn207] Securitization has also benefited investors by allowing them to purchase an interest in the high interest rate loans that have been associated with predatory lending. those that set up reserve accounts that fund losses. where. the holder in due course doctrine. if violated. Investors are pr otected from much of this r isk by two methods. this ability to rely on a single rating may be overshadowed by the increased complexity that securitization adds ***Page548 to the investors' financial decisions. such as those engaging in tax evasion and money laundering. [Fn210] While the GSEs claim that their securitization has led to lower interest rates. At most. a recent study by the Federal Reserve Board suggests that securitization may not decrease interest rates. Recourse can take several forms. lenders will be able to offer loans at lower interest rates or with otherwise better terms to borrowers. even apart from unstable economic conditions. [Fn203] However. require the seller to repurchase the loan. Even those articles that sing the praises of securitization ra rely mention in any great deta il the effect of securitization on the homeowners whose loans have been securitized. while avoiding much of the risk of defaults and delinquencies that is associated with those loans. which may. by obtaining access to lower cost capital markets. [Fn211] .

there are few long term relationships. more often than not a mortgage broker. In the world of securitization. so that loans from different lenders can be pooled together and rated in a uniform manner. The Downside and Dangers of Securitization. especially among borrowers with poor credit. [Fn212] As originators immediately sell their loans and face less risk of loss even if a borr ower defaults. and the Holder in Due Course Doctrine. Securitization has forced the static standardization of loan documents. as GSEs such as Fannie Mae and Freddie Mac have mandated that specific. As discussed in section IV(C) infra. [Fn213] Ninety-eight percent of mortgage companies now use some form of automated underwriting. The "Unbundling" and "Atomization" of the Residential Mortgage Industry Securitization has accomplished what is known as the unbundling of the loan industry. to alter the terms of their form contracts. [Fn214] In this way. standardized forms be used in any loan that they purchase. such as a master servicer under the trustee's direction. on an individual basis. though the default and foreclosure would likely occur long after the original lender has assigned the loan. through their ownership of securities issued by the SPV holding the mortga ge in trust with a pool of other mortgages. preparing the documentation for the loan. Securitization. foreclosure rates. [Fn221] These investors. lenders performed all of the functions of a loan. finding the borrowers. requires lenders to use form loan contracts that a re standardized acr oss the lending industry. claim the capital represented by the mortga ge. and another may securitize the loan and sell it to investors. [Fn222] . borrowers are more likely to ***Page551 default on their loans and risk foreclosure. securitization has encouraged the decline of stringent underwriting. with its ever churning markets. while a separate set of entities. "atomized" this process. funding the loan. are increasing dramatically. in both selecting which loans to make and controlling those loans once made. [Fn220] so that one distinct entity. while another. and servicing the loan thr oughout its life. [Fn217] Securitization. banks step away from their great strength. disassembling the lending process into its constituent elements. ***Page552 D. however. First of all. to improve the terms of those loan documents. 503 (2002) Page 24 ***Page550 C. lender-driven underwriting and instead depends on systemic controls that can be objectively verified. Jacobides. effectively bargaining over the terms of the form contracts even among sellers who refuse. and this standardization has removed the power of consumers. such as automated underwriting systems. in the words of Michael G. [Fn219] Traditionally. funds the loan. The seller with the best terms will find more customers. and allowing a separate entity to undertake each element. perhaps a mortgage banker. which was the effectiveness and efficiency of their information gathering and regulation systems. thus increasing the risk of lending money to borrowers with a high level of default risk. [Fn218] Therefore. forcing the other sellers to offer better terms. 35 Creighton L. Careful underwriting reduces foreclosure against borrowers by deterring lenders from making loans to borrowers unable to repay the loan. [Fn216] Posner assumes that the dangers of form contracts are alleviated by the ability of consumers to choose sellers based on the ter ms of their form contracts. accepting the mortgage payments and foreclosing if necessary. holding the mortgage during the course of the loan.Held Up in Due Course: Predatory Lending. Securitization has. Securitization reduces the amount of individual. even for loans not slated for GS E purchase. but only the financial equivalents of one night stands. and in using their long-term relationships with borrowers. The market dominance of these GSEs is so great that the forms they have promulgated have become the industry standard. a ccording to a 2001 survey. acting en masse. borrowers have lost what little power they formerly had to alter the terms of the lending contracts they sign. [Fn215] With less lender supervision. originates the loan. Primarily to Borrowers Mostly ignored in the literature on the wonders of securitization are the ways it can cause significant harm to borrowers. services the loan. Rev. the originators naturally will spend less time and effort screening potential loans for default.

. the scope and intensiveness of that regulation is often modest compared to that directed at other lending institutions. and were required by regulators to hold sizeable assets. 35 Creighton L. who then sell them onto the secondary market. borrowers typically dealt with large fina nce companies. even if a smaller loan would be more appropriate for the borrowers. that he can no longer help the borrower if the servicer attempts to foreclose. [Fn230] The amount of regulation of mortgage brokers varies dramatically by state. The SPV and the owners of its securities can claim to be holders in due course and protected from any accountability for the fraud of the mortgage broker. . [Fn224] Mortgage brokers are less regulated than finance companies and less constrained. 503 (2002) Page 25 This separation of the mortgage process confers on each entity in the chain a plausible deniability of the actions of the others. as brokers could be tempted to seek out the lenders that provide the greatest payments to brokers rather than the best rates to borrowers. [Fn232] Some states have virtually no regulation. [Fn229] The use of brokers has hastened the growth of subprime lending. E. once the loan is out of his hands. [Fn231] Some states require a bond or a minimum net worth. . the origination of mortgages has largely been turned over to mortgage brokers. however improper. [Fn223] Because these lenders continued to hold the borrowers' paper. [Fn226] A wholesale lender might purcha se loans from a thousand different independent brokers and bankers from around the country. a state where you can talk about becoming a mortgage broker over breakfa st and open an office in the afternoon--no license. "It's too easy to get into this business . "A lot of states have no licensing and no bonding requirements. [Fn236] Not until 1998 did California. given that ***Page554 brokers have placed some borrowers who would qualify for conventional loans into subprime loans. According to the vice president of the National Mortgage Bankers Association. [Fn235] As a sign of how weak the regulation has been. as borrowers r etained any defenses they had to the loans and the borrowers could also seek damages against the finance companies. which funded their own loans and held the ***Page553 loans in their own portfolios. to maximize the brokers' commissions. It's not good that you could be selling paint at Sears one week and originating loans the next. I live in Michigan. and the Holder in Due Course Doctrine. . [Fn225] While mortgage brokers themselves directly interact with the secondary market very little. [Fn227] This use of brokers may lead to higher fees charged to borrowers. who now originate over sixty percent of all residential loans in the United States. were closely regulated. the finance companies had diminished incentive to commit outright fraud against the borrowers. because brokers' fees are commonly a percentage of the total loan. but rarely enough of either to protect bor rowers in an era when many homeowners are borrowing hundreds of thousands of dollars at a time. and on the Front Line of Residential Lending Before the rise of securitization. [Fn228] Also. brokers have an incentive to encourage the borrowers to take out as large a loan as possible. Securitization. from holding a broker's license. because of the greater broker fees from subprime loans.Held Up in Due Course: Predatory Lending." [Fn234] Even in the majority of states that regulate mortgage brokers. either in their company or individually and rarely continue to hold the loans they originate. through their ignorance of any such fraudulent behavior. no bonding . which has been at the epicenter of mortgage . the brokers often originate loans for the wholesale lenders. not until 2001 did Ohio take steps to prevent ***Page555 someone already convicted of theft or forgery. since they may have few assets. The securitizer can claim to be unconnected to the broker and unaware of any of his activities. as of mid-2001. With the rise of securitization." [Fn233] A president of a state mortgage bankers association said. Rev. The mortgage broker can accurately claim. Under-Capitalized. Mortgage Brokers: Too Often Under-Regulated. hardly appropriate credentials for the financia l services industry. .

"streamlined" its mortgage broker licensing law by reducing the bond requirement for licensed mortgage brokers who engage in loan servicing. and begin business anew under assumed names. Instead. the broker could easily seek a license from the California Department of Corporations. Such mortgage brokers are free to disappear if they are sued. Hawaii. or vice versa. [Fn244] ***Page557 Simultaneously. since mortgage brokers rarely hold a borrower's notes in their own portfolios. [Fn243] Furthermor e.000. paying up to several hundred dollars per week. leaving him to rent a different broker's license and restart the process. Gone are the days when a lender would normally hold the loan for its full term. though the broker does risk losing her license if fraud is committed under the auspices of her license and that fraud is discovered. they have too little reason to be concerned about any defenses the borrower might have to the note. and the Holder in Due Course Doctrine. in 2001. stripping the rent-a-broker's license is all that a state's licensing officials ca n do to target the license renter. 503 (2002) Page 26 fraud. and by the small capital required to broker or originate loans. securitization encour ages the most rapid creation of an assignee with holder in due course status by causing the originator of the loan to sell the loan almost immediately. [Fn240] Often. Leland C. stating. if a broker was faced with having his license revoked by the California Department of Real Estate for fraudulent activity. ***Page556 Although it is a stretch to suggest that anyone with a modem and a fax machine can be a lender today. as the two departments did not share information about disciplinary action or consumer complaints. Brendsel. [Fn237] While California and Ohio are finally moving to increase their regulation of mortgage brokers. almost bragged about the ease of entry into the lending business. 35 Creighton L. Rev. take steps to prevent mortgage brokers who had a license revoked by one of its departments from seeking a license from a separate department. [Fn238] The paltry existing regulation of mortgage br okers may be easily circumvented by a tactic called "rent-a-broker" in which those barred fr om obtaining licenses or otherwise unable or unwilling to become brokers themselves rent the use of a broker's license. [Fn241] A mortgage broker could easily be judgment-pr oof in the states that do not require them to be bonded or to maintain a minimum capital. move to another state.Held Up in Due Course: Predatory Lending. the Chairman and Chief Executive Officer of Freddie Mac. it dramatically reduces the likelihood that the bor rower can obtain any sor t of repayment for her damages from the broker or originator. [Fn242] Disreputable brokers have been known to declare bankruptcy. and even less to become a mortgage broker. because securitization allows individuals with little or no capital of their own to originate or broker loans.000 to $15. though she would retain an action for damages against the broker or originator who defrauded her. the unbundling of the loan origination and securitization process. relatively little capital is required to start a mortgage banking operation in the 1990s. lenders might hold the loan for a . trimming the bond from $50. However. who can easily avoid paying any sizeable damages judgment by declaring bankruptcy or merely disappearing. Securitization. Until then. especially if those defenses are immediately cut off as to assignees by the holder in due course doctrine. Lenders lacking the necessary net worth can still originate loans for lenders qualified to sell into the secondary market. as between the borrower and the investors who pur chased a securitized interest in the note of the borrower. that movement is not universal. The securitization process allows even someone with almost no capital or financial services to exploit this lack of regulation and become a lender or otherwise originate loans. [Fn239] The licensed broker likely engages in little or no supervision of the renter's use of her license. The borrower who has been defrauded by a mortgage broker or originator of the loan is victimized by the combination of the effect of the holder in due course doctrine. Except for the real defenses. the homeowner/borrower bears the risk of fraud or misrepresentation by the mortgage broker or originator of the loan.

Various victims of GDC's sharp practices spent most of the rest of the 1990's attempting to recover some of their damages. The appellate court . offering up to $160 million in restitution. [Fn252] and by selling registered subordinated debentures. in 1998. GDC agreed to a plea bargain on a conspiracy charge. (GDV). [Fn259] The court found that. a trustee of a mortgage pool. After GDC was indicted. that defense has already been cut off as to the current holder of the note by the holder in due course doctrine. (GDC) and financed the purchase through GDC's subsidiary. [Fn245] "When we buy from Old Kent. Nationsba nk Trust Company ("Nationsba nk"). who purchased a home from GDC in 1986. [Fn258] those fraud convictions were overturned in 1996 when the court of appeal declar ed that the home buyers could not have been defrauded by the GDC executives because buyers had been free at any time to investigate the prices of other Florida ***Page559 homes. the mortga ges they obtained based on these inflated appraisals often reportedly far exceeded the true market value of the houses that secured the mortgages. [Fn261] Two such victims of those sharp practices were Cedric and Elizabeth James. because GDC's scheme could not deceive buyers with ordinary prudence and comprehension. in the course of building 10. it is permissible to deceive anyone with below average pr udence and comprehension. by selling them under-secured loans. GDC filed a Chapter 11 bankruptcy petition." [Fn256] In November 1990." said a supervisor at a securitizer. and the Holder in Due Course Doctrine. [Fn253] GDC was so successful that at one time it held a reported $1 billion in assets and employed 5." [Fn257] Although a federal judge initially sentenced four of GDC's officers to prison terms ranging from five to ten years. [Fn249] When the buyers committed to purchase. 35 Creighton L. [Fn255] and left unbuilt thousands of platted lots and homes without any water or sewer access. if not outright fraud. plied them with roast beef suppers cooked by a local Holiday Inn and attended by GDC employees.Held Up in Due Course: Predatory Lending.000 people. it did not constitute mail fraud. generating over $11 billion in mortgages. GDC. assigning it almost immediately either to a GSE or to another securitizer. what we have to do is retrofit the city. [Fn250] GDC financed its predatory activity by selling loans to institutional investors. GDC brought primarily out of state potential buyers to Florida. [Fn254] On April 6. and towns so poorly constructed and designed that as one city official explained it. poorly regulated lender who immediately negotiates the loan to a securitizer. This combination (initial loan made by a thinly capitalized.. Securitization. 503 (2002) Page 27 few weeks. The borrowers had pur chased a home from General Development Corp. [Fn260] Apparently. Unfortunately for the borrowers. the eighteenth biggest mortgage banker in the nation. and gave them wildly inflated appraisals for the ***Page558 value of GDC's homes. GDC victimized not only the home buyers by obtaining their down payment. the Jameses ceased their mortgage payments. 1990. "they typically have held it for at least 24 hours. the trustee under a loan pooling agreement for the pool containing the Jameses' loan. brought a foreclosure action against the Jameses. but also the buyers of the mortgages. [Fn248] in which the borrower/homeowners were fighting to prevent foreclosure by the holder of the loan. "Basically." [Fn246] Often. so that if the homeowner /borrower learns that her payments are much larger than had been represented to her. engaged in what appears to be a scheme to fleece naive home buyers.000 homes between 1983 to 1989 and originating the loans to pay for those houses. Nationsbank Trust Co. The trial court dismissed the Jameses' counterclaims and defenses to that foreclosure action and entered a summary judgment of foreclosure. Thus. For example. would sell the loans it generated in less than sixty days. though the special master administering the deal noted there "may not be enough money to cover all such claims. so that the investors in the securities can claim holder in due course status) is a recipe for irresponsible and unethical lending. GDV Financial Corp. after Nationsbank claimed it was a holder in due course. Old Kent Mortgage Co. [Fn251] some of which were securitized by those institutional lenders. and often much less. the loan will be sold before the first payment is even due.. Rev. This way we can ensure they actually own the loan. [Fn247] An example of such sharp practices can found in the case James v.

[Fn273] The investors are not even notified of the default of an individual borrower. then the borrowers' defenses based on the fraud conducted by the originator of the note would be cut off due to the trustee's holder in due course status. the willingness of servicers to work with borrowers is subject to the servicers' conflicting interests.Held Up in Due Course: Predatory Lending. Rev. beneficial owners. which normally held the loans for their entire terms. who depend on the trustee and servicer to control the assets. alternatively. [Fn265] This relationship allowed lenders to step in early and encouraged resolution of borrower difficulties without the need for formal collection efforts. [Fn268] The trustee and servicer of the loan. The buyers ar e only beneficial owners. since the investors are passive. Securitization. the trustee is forbidden from accepting instr uctions that conflict with the terms of the securitization agreement. [Fn262] However. let alone communicate with them. [Fn263] The holder in due course doctrine and securitization provided support for GDC in its schemes. and the trustee controls the assets but does not benefit from them (except by fees). homeowners typically borrowed from their neighborhood banks. [Fn266] While a borrower whose loan is held by a traditional bank might have some success in convincing the bank to restructure the loan. and the Holder in Due Course Doctrine. 503 (2002) Page 28 reversed and remanded only as to the Jameses' allega tion that Nationsbank was not a holder in due course. [Fn269] The trustee and servicer do have some discretion to create a loan repayment plan. [Fn272] It would be practically impossible for a borrower even to learn the identities of the investor. 35 Creighton L. it appears that unless the Jameses could somehow show that the trustee had such knowledge of the originator's fraud at the time the trustee acquired the mortgages for the pool. [Fn274] Even if investors wanted to overrule a trustee's order to foreclose on a homeowner. as the servicer may be rewarded either for preventing foreclosures by instituting quick and successful repayment plans or. making them far more willing to buy those loans because they were protected from most claims by the homeowner/borrowers. [Fn275] Once the deeds of trust are securitized. a discretion that can aid investors given the ***Page561 expense of the foreclosure process. because the lender might know of a factory closing or of a borrower's severe illness. too much of this flexibility vanishes once the loan has been securitized. That documentation often limits the discretion to alter the terms of the loans because the securities backed by the loan pool are based on the loans' original terms. [Fn271] The borrower cannot turn for succor to the investor s who own the securities that are backed by the borrower's loan. especially in states which do not allow non-judicial foreclosure. both by providing financing for GDC's efforts and by giving protection to the investors in the loans originated by GDC. even if either is the original lender. "Tr anche Warfare" and How Securitization Reduces Lenders' Discretion in Resolving Borrowers' Difficulties Securitization hurts borrowers by making it more difficult for a borrower with financial difficulties to arrange alternative payment terms that involve any change in the borrower's payment stream. they enter into what Tamar Frankel has called "a kind of suspended animation. Because of those long-term." [Fn276] . local relationships. or arrange a short sale. ***Page560 F. [Fn270] However. [Fn264] Before the advent of securitization. for negotiating short sales by the borrowers or foreclosing as quickly and efficiently as possible. lenders were often aware of their borrowers' troubles even before the borr ower missed a payment." noting that "the sellers of the financial assets are no longer the owners. [Fn267] The originator has often washed its hands of the loan and has neither the ability to nor the interest in helping the borrower change the terms of the loan. based on the Jameses' allegations that Nationsbank had purchased the pool of mortgages with actual knowledge of GDC's use of fraudulent appraisals that misrepresented the value of the homes. must follow the documented procedures that are normally included in the initial documentation of the securitization. a loan modification.

because it would almost inevitably involve removing some part of a stream of income from one tranche and adding income to ***Page563 another tranche. and the Holder in Due Course Doctrine." so to speak. leaving the trustee open to claims of favoritism and breach of fiduciary duty by the owners of securities in the tranches that bear the brunt of the restructuring. the underlying structure of the securities throw roadblocks in front of the exercise of that discretion. and the lender can receive a fair return. would force trustees to choose which of the tranches would receive extra money and which would receive none. possibly even to the traditional lender's benefit. yet another to interest payments the second year. Once the loan has been securitized. to resolve the dispute with the homeowner would be to restructure the loan. If the loan has been securitized into tranches divided by principal and interest and by the year pr incipal or interest is received. therefore. [Fn279] A bank could forego mortgage payments for the life of a borrower with little financial detriment. The weight of these inefficiencies falls primarily. when discovering this fraud. the same agreement to forego payments would strip the tranches receiving early payments of principal or interest of all benefit fr om this particular loan. The trustees' fiduciary dilemma does not disappear even when the homeowners sue. In this way. perhaps through no fault of his own. on the party that neither approved of nor likely even knew about the possibility of ***Page562 securitization. 503 (2002) Page 29 Reducing the amount of discretion any pa rty has to alter the terms of the borrower's loans or payment requirements may aid investors and improve the liquidity of the loan pool. by refusing to restructure loans voluntarily. this flexibility to restructure the loan repayment is dramatically reduced. A common way for the holder of the note. [Fn281] As loan pools are split into increasingly complex tranches. if not exclusively. Securitization itself has made the borr ower's life more difficult by removing the personal discretion of the holder of the note to make exceptions for a borrower who. trustees will find it virtually impossible to restructure loans without harming securities owners in some tranches more than others. is forced to miss one or more payments on his note. preventing them from working out mutually advantageous changes to the terms of the note. [Fn278] Restructuring the loan poses a substantial fiduciary dilemma to the trustee. since the loan is no longer held as a unitary asset by one owner. but rather has been split into a number of tranches. "tranche warfare. Securitization. another to interest payments during that year. In effect. [Fn280] Restructuring loans.Held Up in Due Course: Predatory Lending. and even where the trustee and servicer would want to help out a financially troubled borrower. Imagine an elderly homeowner who has been the victim of fraud by a mortgage broker in the origination of the refinance of his home loan. [Fn277] Even in cases where the foreclosure criteria contained in the initial offering of the securities backed by mortgages give the trustee some discretion regarding when and whether to foreclose. or forbearing on requiring repayment of either principal or interest while the homeowner is alive and instead collecting some or all of the loan after the elderly homeowner dies. and so on. r educing the interest rate. so long as there is sufficient collateral to secure the loan and the interest rate is competitive to the then current market rate of interest. and so might well react. This could force homeowners to resolve their disputes through litigation. Rev. and would instead cause other tranches receiving later payments to receive a much greater sum than they would have obtained if the loan had not been restructured. but it can also force a trustee to foreclose where a traditional lender might merely have restructured the loan. the securitization process erects a wall between the borrowers and the beneficial owners of the note. either by reducing the amount of the principal. This dramatic increase in the transaction costs between borrower and beneficial note holder leads to great inefficiencies. making the process of . however. so as not to risk breaching their fiduciary duty. the borrower. whenever possible. the homeowner can live out her remaining years in peace. each tranche representing different interests held by different sets of investors. 35 Creighton L. delayed by an uncertain number of years. One tranche might hold the right to any principal repayments made during the first year.

discussed below. ***Page566 or even the type of creditor. The SPV is a business entity whose sole purpose is to hold a mortgage pool. [Fn285] Securitization almost completely depersonalizes the lending process and deprives the borrower of the advantages of a personal relationship with her lender. who would want to avoid tying their firms' valuable reputation to predatory lending. she might want to pick as the holder of her note a company with a reputation for being reasonable with borrowers in distress. a debtor should be able to pick who his creditor would be and to avoid borrowing from anyone brutal enough to demand that his debtor be imprisoned. such as a small bank instead of a large bank or an individual investor. [Fn286] There is an odd echo here of the underlying purpose behind the ancient prohibition against assigning a chose in action. since the homeowners have no choice whatsoever regarding which servicer collects the payments on their loans. for example. 503 (2002) Page 30 settling litigation more difficult. which is often something like "Security Pool #351. atomizing the mortgage origination and collection process. The parties to the secur itization who may most be affected by bad publicity are the underwriters. whom would a defrauded borrower picket in order to obtain a loan forbearance? [Fn283] The originator may be long gone. so that the judge can force the trustee to rescind or restructure the loan. an SPV holds the loan. [Fn282] When a mortgage broker solicits the borrower. securitization removes one sometimes potent weapon in the hands of a borrower who needs to have her loan restructured. with an eye to obtaining repeat business fr om the customer or new business from referrals. especially one who was the victim of fraud. [Fn287] Now that a borrower risks losing her house should she fall behind on her payments. as it serves solely at the direction of the trustee. those banks were susceptible to bad publicity and might be loath to foreclose on the home of. Banks also might have some interest in keeping their customers satisfied. Securitization. . since it gets its business from originators. which was that since a creditor could have his debtor thrown in jail for non-payment of the debt.Held Up in Due Course: Predatory Lending. homeowners might be driven to take their cases to trial. The trustee also does not need to keep the good will of the borrowing public. as many subprime lenders have in recent years declared bankruptcy and gone out of business. the trustee and servicer can always claim. almost nameless. correctly. Securitization. A reputation as a particularly ruthless collector of debts ***Page565 might well aid the trustee or servicer in gaining new originator clients. not the borrowers. and a servicer collects the payments. Rev. on the other hand. The servicer little depends on the happiness or good will of the homeowners who make payments to it. they did continue to participa te in the securitization of residential loans without attempting to root out fr audulent lenders despite widely publicized hearings in 1994 and 1998 that documented how many lenders were taking advantage of unsophisticated borrowers and that the problem was growing dramatically. 35 Creighton L. has allowed the markets to be unbundled. as it sweeps up the vast majority of American mortgages into faceless. to be bound by the foreclosure criteria contained in the initial offering of the securities and absolve themselves of any responsibility to exercise discretion in dealing with a desperate homeowner. " The ser vicer is similarly immune to threats or pleading. As a ***Page564 result. an elderly borrower. unknowable business entities. [Fn284] Furthermore. Securitization eliminates the ability of a borrower to pick his creditor. While Wall Street firms might avoid individual firms linked to predatory lending (though their continued support of finance companies like First Alliance. When loans were held by regional or local banks. and the Holder in Due Course Doctrine. so that borrowers can threaten to picket a bank or bring discredit to the brand name unless the bank acts reasonably in helping borrowers resolve their problems. throws even that supposition into doubt). large Wall Street firms. Similarly. Banks have locally recognizable brand names. and is completely immune from any threats to its good name. like Lehman Brothers and Prudential Secur ities.

[Fn290] Small lenders in particular often sell their loans "servicing released. "Usually the servicer of the SPV's portfolio is the loan's originator and the payee under the notes. 503 (2002) Page 31 G. [Fn300] The new U. omits this requirement.C." [Fn292] The Kravatt treatise on securitization describes in detail the efforts tha t a securitizer of r esidential mor tgages should take to become a holder in due course and further notes. Securitization. allonges are allowed even when there is space for more indorsements on the instrument. or endorsing it and delivering it. with originators discovering that they can avoid the volatility associated with servicing. the case. the servicing rights to loans are easily and widely bought and sold.C. therefore. Now. presumably to preserve the record of previous endorsers in an orderly fashion. [Fn299] Similarly. [Fn301] .C." meaning that the buyer of the loans also obtains the servicing rights to them." [Fn296] Even Ginnie Mae's recent streamlined document requirements still requires that a "complete chain of endorsements up to the pooling of the loan must be evident.C. [Fn291] Steven Levine and Anthony Gray assert that "[o]riginators typically endorse and deliver notes to issuers. the GSEs that have been the driving engines of securitization. and the Holder in Due Course Doctrine." [Fn289] While originators were formally the usual servicers of the loans they originated. further endorsements are not required. [Fn297] The new rules for endorsement under the revised U. requiring only a "paper affixed to the instrument" and leaving open the possibility that allonges could merely be paper-clipped or otherwise loosely attached. notes are not endorsed. this is no longer universa lly. denying a loan purchaser status as a holder in due course where. [Fn288] Tamar Frankel stated. the simplest way to transfer an ownership interest in the note is to negotiate the note by delivering it to the pool entity if the note constitutes bearer paper. The Survival of the Holder In Due Course Doctrine in the Age of Secur itization Some have argued that the advent of securitization has effectively eliminated the holder in due course doctrine. For example. by transferring the servicing rights to a company that. in practice. Article 3. previous law required an allonge to be so firmly affixed as to be part of the original document. Freddie Mac's Single-Family Seller/Servicer Guide requires a seller to endorse notes delivered to Freddie Mac without recourse and states "If the Seller is not the original payee on the Note. r equire that the notes be endorsed before they can be securitized. not a holder in due ***Page567 course." noting that "in the absence of such endorsement and delivery. and that the "last endorsement on the note should be that of the mortgage seller. the transferee would be the owner of the note but not the holder and. if the note constitutes order paper. by and large. for example.C. stating that the process of indorsing each of the hundreds or thousands of notes that make up a mortgage pool would be so time consuming as to be impractical. can derive greater profit from those rights." [Fn293] While there may well be securitizers who do not ensure that each note is indorsed to a new holder. it failed to staple its allonges to the back of its notes. it is simpler to staple an indorsed allonge to each of a large number of notes than to inscribe an endorsement on the backs of each of them.Held Up in Due Course: Predatory Lending. Therefore. without recourse. 35 Creighton L. make it easier to endorse a large number of notes. and the originator remains the holder of the notes. or even generally. [Fn298] Under the new revision of U.C. Rev." [Fn294] The document custodian handling this volume of documentation is required by Freddie Mac to "verify that the chain of endorsements is proper and complete from the original pa yee on the Note to the Seller delivering the Note to Freddie Mac--not to the Servicer." though after the note is endor sed in blank when the note is placed into a Ginnie Mae pool. "If a note is negotiable. the chain of endorsements must be pr oper and complete from the original payee on the Note to the Seller. Previous law ***Page568 arguably allowed the use of an allonge only when there was insufficient space on the back of the negotiable instrument for a new indorsement. For example. because it specializes in servicing." [Fn295] Fannie Mae requires the lender to endorse the note in blank. such as varying prepayment rates by borrowers.

C. (c) the trustee received the note as part of a bulk tra nsfer of 141 mortgages. claiming that the trustee was not a bona fide holder because (a) the trustee did not have physical possession of the note. The court found that while FHCMC was an undisclosed principal and normally would be bound by the actions of its agent. 35 Creighton L. not the court. The trial and appellate courts agreed. but just for servicing them. finding that Ginnie Mae became a holder when its agent received the notes indorsed in blank and that Ginnie Mae gave value for the notes by delivering a security to the other mortgage company. the court found that the adjustable rate feature of the mortgage prevented the tr ustee from being a holder in due course under thenexisting Virginia law. in C. FHCMC held the loan free of any defenses the borrower may . and the Holder in Due Course Doctrine. Rev. The trial court directly refuted the assertion by many modern academics that the holder in due course doctrine no longer plays a role in the modern mortgage system.W. but never paid the original holder of the mortgages. SSB.C. claiming that the loan should have been non. There. [Fn308] In Dupuis v. The second corporation delivered the mortgages to one of Ginnie Mae's document custodians for pooling in a Ginnie Mae mortgage pool. Haynes contends that this protection is unnecessary in modern day transactions because a merchant can "require ***Page570 the strictest accounting from the person whom he is receiving the instrument. Because the servicer was not FHCMC's agent for the purpose of obtaining or closing loans. [Fn309] the court also found the holder in course doctrine to be relevant to securitized loans. [Fn304] The court beat back each of these objections to holder in due course status. [Fn306] Similarly. and so he took the loan free of any personal defenses such as reformation. Ginnie Mae asserted its status as a holder in due course as a defense. despite the fact that it purchased so many loans from the servicer and made the servicer its agent. finding that the trustee did not need to have personal physical custody of the note so long as the note was held by its agent. and that the information contained in the pooling agreement did not constitute proof of actual knowledge required to disprove the good faith of the holder. [Fn310] The court also found FHCMC to be a holder in due course. then any abolishment of that body of law should come from the legislature. [Fn302] in which two general partners of a limited partnership sought to reform a note to avoid persona l liability on it. and the mortgage notes are clearly negotiable. should not apply in this case and the holder in due course doctrine is no longer warranted. 503 (2002) Page 32 Evidence that securitizers do in fact indor se their notes can be found in the case Bankers Trust (Delaware) v.. indorsed the remaining mortgage notes in blank. because FHCMC was a government sponsored entity. that the trustee had delivered value for the note by delivering the securities in exchange for the mortgages. [Fn305] In the end. after returning four of the loans. Securitization. [Fn307] the original holder of twenty-one mortgages indorsed them to another mortgage corporation that.C. which denies holder in due course status to a bulk buyer of mortgages. [Fn303] The trustee of the securitization asserted that it was a holder in due course. an agent could not bind FHCMC beyond the agent's authority. Midfirst Bank. The partners furiously challenged the trustee's holder in due course status.C. and (d) since the pooling agreement stated that all of the loans in the pool were non-recourse.recourse. Article Three of the U. When the original holder sought to invalidate the transfer to the second mortgage corporation and to Ginnie Mae. Haynes v. that the bulk assignment exception. controls tr ansfers of negotiable instruments. did not apply because the trustee did not receive the note as part of a bulk sale of a portion of the seller's entire assets. stating: Haynes argues that UCC Article Three should not apply in this case because the rationale underlying the good faith purchaser for value concept (embodied in Article Three as holder in due cour se) no longer applies in modern day transactions.Held Up in Due Course: Predatory Lending. ("FHCMC")." However. If U. not the trustee). (b) the trustee did not ***Page569 acquire the note for value (arguing that the investors paid for the note. the trustee had knowledge of the partners' defense when it acquired the loan. though. Federal Home Loan Mortgage Corp. 236 Beltway Investment. alleging that the servicer of a pool of loans was an undisclosed agent for FHCMC and had defrauded her by failing to disburse to her the full amount of her loa n or to credit her with payments she made to the servicer. a homeowner brought suit against Federal Home Loan Mortgage Corp.

the prime market normally deters predatory lending because it is conducted by such regulated entities as banks and credit unions. which averaged 7. [Fn322] and serves communities that have in the past been under-served by more traditional lenders. has been the enormous growth in subprime lending.fold in just six years. both in terms of interest rates and points and fees." according to a state consumer affairs official.000 in 1993 to 856. Professor Lesser Mansfield reports that when she reviewed SEC filings for the interest rates of the subprime loans that had been placed in securitized pools. "The holder in due course doctrine is often asserted in consumer transactions. [Fn321] Subprime lending is also referred to as "B/C" or "nonconforming" credit. [Fn317] Subprime loans are made typica lly to borrowers with limited or impair ed credit histories. For example. or who have a large amount of debt given their income. aver aging ten to fifteen points in fees. in addition to securitization. [Fn324] According to a Treasury report. 35 Creighton L. [Fn316] a growth fueled by securitization.99% in 1999. for home improvements. as well as through robust competition among lenders. THE RAPID AND TROUBLING GROWTH OF SUBPRIME LENDING A." [Fn314] By comparison.43%. more informed borrowers and simpler.Held Up in Due Course: Predatory Lending. and the Holder in Due Course Doctrine. or to refinance an existing loan.99%. [Fn320] Also. [Fn311] These cases illustrate that the holder in due course doctrine still plays an important role in the assignment of risk in the modern mortgage industry. the subprime market is used far more often by borrowers seeking either to consolidate debt or to purchase home improvements or consumer goods. from 66.000 in 1999. and not to purchase the home. [Fn318] Some subprime lenders specialize in serving customers who are unable or unwilling to provide credit documentation. or three to five times as much as the three or four points typically charged for . [Fn315] The number of subprime home equity loans increased thirteen. particularly direct loans secured by mortgages. which has been defined by federal banking agencies as "extending credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than tr aditional bank lending customers. more homogenous loan terms. with a median interest rate between 11% and 11. Securitization. 503 (2002) Page 33 have had against the originator of the loan. [Fn312] ***Page571 IV. such as employment history. Subprime Lending and Subprime Borrowers A second major change affecting borrowers recently. much higher than the annualized rate for conventional thirty year mortgages. which has been called a "fertile ground for predatory lending practices. [Fn319] Many of the consumers who obtain subprime loans either ***Page572 have fewer credit options than other borrowers or perceive incorrectly (a misperception often created or fostered by a subprime lender) that they have fewer such options. [Fn327] Subprime loans also include much higher points and fees than pr ime loans. [Fn325] More than one half of fir st lien subprime mortgages and up to seventy-five percent of second lien subprime mortgages are used for debt consolidation as well as other consumer ***Page573 credit purpose. which is typically entered by borrowers seeking either to purchase a home or to refinance an existing loan at more favorable rates." [Fn313] Any ana lysis of predatory lending must include a discussion of subprime lending because most predatory lending occurs in the subprime market. [Fn323] Unlike the prime market. subprime loans include those too small for most prime lenders. Rev. [Fn326] Subprime loans are significantly more expensive than prime loans to borrowers. those filings showed an interest rate range of 3% to 19. over seventy-five percent of the growth between 1993 and 1998 in subprime lending to low to moderate income borrowers and areas can be attributed to refinancing of existing loans rather than to new loans for the purchase of a home.

GSEs such as Freddie Mac and Fannie Mae have the same market share in upper-income black households as they do in the very low-income white market. to be delinquent on their payments. [Fn333] Subprime lending is disproportionately prevalent in low income and minority neighborhoods. who compared interest rates on loans rated A-minus and originated by subprime lenders with loans rated A-minus by a Freddie Mac underwriting model and purchased as prime loans by Fr eddie Ma c. with the increased ability to obtain inexpensive credit information about borrowers in low income neighborhoods through commercially available and nearly instantaneous credit scoring. Despite the identical A-minus rating.Held Up in Due Course: Predatory Lending. is living off of credit cards. the subprime loans averaged 215 basis points higher. For example. [Fn328] The excessive interest rates pa id by many subprime borrowers have been documented in a recent study by Freddie Mac researchers. [Fn343] The subpr ime market has until recently been increasing at a rapid rate.income neighborhoods. [Fn341] The ideal customer for a subprime loan has been described as "a n uneducated widow who is on a fixed income . [Fn330] Subprime borrowers are more likely than prime borrowers. and with subprime refinancing five times more likely in predominantly black neighborhoods than in predominantly white neighborhoods. much more rapidly than the remainder of the lending market. though still only 2. [Fn339] While the question is contested. both of which drive up the costs that lenders must charge subprime borrowers. 35 Creighton L. on average. current research indicates that credit discrimination against minority borrowers persists. 503 (2002) Page 34 conventional borrowers. who has her house paid off. [Fn340] ***Page576 Subprime lending is also aimed at elder homeowners. [Fn338] However. with thirty-nine percent of high income homeowners in black neighborhoods using subprime financing compared to only eighteen percent of low income homeowners in white neighborhoods. [Fn332] Lenders further argue that subprime loans require increased due diligence costs and that servicing subprime loans is more expensive. [Fn344] Between 1993 and 1998.73%. the disparity between the use of subprime lending in black and white neighborhoods is so great that borrowers in high income black neighborhoods relied on subprime refinancing twice as much as borrowers in low income white neighborhoods. [Fn329] Lenders argue that they charge higher interest rates and fees for subpr ime loans because of the increased risk characteristics of subprime***Page574 borrowers. while sixty percent of prime loans involve college graduates. [Fn335] This targeting of minority neighborhoods can par tially be attributed to the fact that these neighborhoods have been traditionally ***Page575 under-served by prime lenders." [Fn342] Subprime borrowers are typically less educated than prime borr owers. the level of subprime loans delinquent by ninety days or more was ten times that of conventional loans. and the Holder in Due Course Doctrine. subpr ime mortga ge refina ncing grew . [Fn337] Historically. Securitization. [Fn331] Market researcher Mortgage Information Corp. [Fn334] Worse yet. . but having a difficult time keeping up her pa yments. the refusal of lenders to provide credit in low income or minority neighborhoods could be explained by the increased cost of obtaining accurate information regarding potential creditworthy borrowers in neighborhoods where they are less likely to be found. . Rev. many of whom have significant equity in their homes and need funds either for home repairs or for retirement. [Fn336] By comparison. and who must make a car payment in addition to her credit card payments. only thirty-eight percent of subprime loans are taken out by college graduates. being thr ee times more likely in low-income than high. combined with the computer enhanced ease of manipulating this flood of data. lenders should be able to find creditworthy borrowers wherever the borrowers live and whatever their r ace or ethnicity. reports that at last year's end. though this increased delinquency is due in part to the higher interest rates and fees charged to subprime borrowers. 100 basis points of which could not be explained.

Securitization. somewhat grudgingly. $1 billion the third. [Fn360] DIDMCA further pr eempts state laws by allowing a state. $100 million the next. Although it is not clear tha t Congress intended to preempt usury laws for non-purchase money loans. [Fn361] Naturally. or over one third. of the roughly $240 billion worth of subprime mortgage loans that were outstanding. The Road to Subprime "HEL" Was Paved with Good Congressional Intentions: Usury Deregulation and the Subprime Home Equity Market. a subprime lender can lend far more money during the course of the year than its balance sheet would otherwise make possible. Wall Street fir ms began "making short-term loans to subprime lenders. and HUD-approved lenders under the National Housing Act. had ***Page578 been securitized. Wall Street quickly grew interested in securitizing subprime loans. the Wall Street firms not only received interest on the short term loans. and the Holder in Due Course Doctrine. but gradually taking a larger role. . [Fn352] By 2000. [Fn349] B. then purchased by banks. and the other half as B. this exportation and preemption encourages lenders to be based in states with little or no usury regulation. shaken by Russia's default on its foreign debt. [Fn347] Half would be categorized as A-. [Fn355] In this way. [Fn350] After a few successful securitizations of subprime loans. A number of subprime lenders went out of business. concluded that DIDMCA applies to all first position liens." said Cary Thomson." giving subprime lenders capital to make more loans. [Fn359] DIDMCA preempts state usury ceilings on first ***Page579 mortga ge loans that are made by most lenders. 35 Creighton L. C and D paper. a major subprime lender. ready to start again at a moment's notice if the market changed. [Fn358] Cathy Lesser Ma nsfield traces the enactment of DIDMCA. Rev. receiving back the pr incipal on the loan while retaining a s an immedia te profit the lenders' fees and often a portion of the securitized tranches. A primary one is that the existence of ready capital available to lenders through the securitization of subprime loans has dramatically increased their ability to make those loans. were doing $50 million in underwriting the first year.chartered financial institution to export the law of its own state into any other state where it does business. initially simply handling the securitization and finding investors.000 loans to more than 800. [Fn346] It is estimated that loan originations in the subprime market have increased from $35 billion as of 1994 to $160 billion five years ***Page577 later. about $100 billion. most subprime loans were not securitized and instead "were sold as whole loans to individua l investors" looking for high investment returns and not frightened by substantial risk. while refinancing from prime lenders barely increased. Before the 1990s. The reliance of subprime lenders on the secondary mortgage mar ket can be seen in the reaction of the subprime market to the 1999 liquidity crisis. which occurred when investors. The Causes of Subprime Lending's Increase This increase in subprime lending can be explained by a number of factors. such as banks. starting out.000. with total outstanding subprime loans of $426 billion at the end of 1998. CEO of Aames Financial Corporation. withdrew capital from the subprime market. mortgage bankers.Held Up in Due Course: Predatory Lending. which its supporters hoped would increase the availability of mortgage funds by buttressing the viability of savings and loans and by allowing mortgage interest rates to be market-driven. [Fn348] Most subprime loans are made by mortgage brokers. [Fn354] "These independents. [Fn351] In return. 503 (2002) Page 35 from fewer than 100. but a lso additional fees from the increased subprime securitization. [Fn356] Another reason for the increase in the subprime market has been the preemption of state usury laws by Congress. [Fn357] In her excellent article. [Fn353] Lenders have been able to expand rapidly by making loans and quickly selling them to a securitizer or securitizing the loans themselves. [Fn345] The subpr ime market has increased its share of all mortgage originations fr om five percent of all originations in 1994 to almost thirteen percent of all originations in 1999. primarily by the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). whether or not the loan involved was used to purchase the property securing the loan. the courts have.

" [Fn372] Foreclosur es are occur ring among subprime loans not only in greater numbers than their prime equivalents. The Links Between the Rise of Subpr ime Lending and the Increase in Residential Foreclosures The number of residential foreclosur es is increasing at a frightening ra te.2 years for prime and Federal Housing Administration ("FHA") loans. [Fn365] This aggressive marketing is so effective that it has captured a significant number of borrowers who could have obtained prime loans at much lower interest rates. but also much sooner in the life of the loan. For example. which rose from 3.906 in 1998. which left mortgage interest as one of the few forms of consumer interest that is still tax deductible.074 in 1993 to 3. creditworthy borr owers in part by contacting homeowners who ***Page580 are not seeking a loan. and the Holder in Due Course Doctrine. Other reasons for the rapid expansion of the subprime market noted by a recent HUD report on predatory lending include: the Tax Reform Act of 1986. [Fn373] Subprime loans account for a vastly dispropor tionate share of foreclosures compared to their share of loan originations. therefore. [Fn377] Their home may be where they raised their family or lived with their . a ra tio comparable to Atlanta's two year s for subprime versus four years for other lenders ***Page581 and Boston's three years for subprime versus seven years for other lenders. [Fn367] Subprime lenders are able to snare prime. especially among subprime borrowers. or fliers. [Fn370] C. perha ps temporary. [Fn363] One homeowner made a common complaint. Securitization. even where the overall foreclosure rate is declining. so that frightened homeowners will reply. The increase in foreclosures corresponded to the increase in originations by subprime lenders. instead of the smaller second subprime mortgages that had dominated the market. leaving more potential buyers with troubled credit history. foreclosures of loans by subprime lenders occurr ed on average when the loan was 1. with the share of subprime foreclosures as much as double the share of the subprime origination.8 years old. and then convincing the homeowners to borrow. as opposed to 3. recent studies indicate that in Baltimore. [Fn369] Since 1999. Mortgage brokers around the countr y obtain borrowers by bombarding homeowners with loan offers. the subprime market has seen a retrenchment. [Fn374] A subprime loan. the rise in consumer bankruptcy and credit card debt. using telephone calls. with many subprime lenders in bankruptcy and the amount of securitization of subprime loans decreasing. with the outcry against abusive lending practices. but the estimates range from a low of ten percent to thirty-five percent [Fn366] to a high of up to fifty percent.953 in 1997. [Fn375] Foreclosures cause intense damage to borrower/homeowners completely distinct from the financial effect of losing a house. and the increase in subprime first mortgages. 503 (2002) Page 36 [Fn362] The subprime lending industry's rapid increase is also due to aggressive advertising by subprime lenders. 35 Creighton L. This explosion in foreclosure rates among subprime loans is a national phenomenon. is not only foreclosed sooner. so as to maximize the profit of both the lender and the broker. door-to-door marketing. but is also much more likely to be foreclosed than a prime or FHA loan. Rev. The exact number of subprime customers who could have obtained prime rate loans is difficult to determine. only to be cajoled into taking out high cost loans. [Fn376] Homeowners often place a value on their home that is incommensurate with the strict financial value thereof. [Fn368] Once they convince the homeowner to borrow.Held Up in Due Course: Predatory Lending.137 in 1991 to 50. One company contacted me twice in the same day. "I get calls and letters every week." [Fn364] One form of deceptive advertising is to send out solicitations that are designed to resemble collection notices. the broker or lender often labors to increase the amount of the loan. [Fn371] The report "Unequal Burden: Income and Ra cial Disparities in Subprime Lending" notes that "completed foreclosures in the Chicago area doubled over the five-year period from 2.

[Fn390] Even this contribution is disputed. sleep loss. . [Fn388] The lender. Rev. can have a punishing effect. been concentrated in low income and minority neighborhoods. . on the other hand. as at least one prominent association contends that this incr ease ***Page584 in minority and low-income home . however. such as foreclosure. In many cases. It combines humiliation with a fear by the elderly victim that she has not only lost ***Page582 her home. affecting the entire community. which has the ironic effect of increasing the risk of default and making foreclosure more likely by making it more difficult for a borrower to make his mortgage payments. Borrowers regularly discount risks. [Fn378] The loss of the home often cr eates psychological and emotional havoc in homeowners. described the systemic effects of the foreclosure: We are seeing a pattern in the city and in the suburbs. which leads to excessive risk taking. [Fn386] One cause of the excessive foreclosures associa ted with subprime lending is that the tr ue cost of foreclosures is not adequately factored ***Page583 into the price of the subprime loan. forever blaming herself for the loss of her home. [Fn387] The lender. which. these homes have been taken over by gangs and drug people. This strategy tends to maximize the borrower's financial loss in cases of foreclosure because the borrower will have more equity in the house to lose. . Given the traditional reluctance of conventional lenders to make loans in lower-income and minority communities. becoming wrecked hulks that are breeding grounds for crime. 35 Creighton L. is much more difficult for the elderly. however. Daley. often felt by elderly victims of fraud. especially where those risks are high. Richard M. [Fn384] Foreclosed homes often stay va cant longer than other homes. subprime lenders have arguably filled a glaring need. [Fn383] Chicago's Mayor. . and the Holder in Due Course Doctrine. that they have never experienced. but could also lose her independence if she is forced to move into a nursing home. It's the same story: A family has suddenly abandoned their home. does not factor in the borrower's costs of foreclosure. depressing property values and economic development. Or. [Fn382] The secondary loss of foreclosure is not limited to that suffered by the borrowers themselves. and idealization of the lost home. with less maintenance. psychological distress. [Fn379] Foreclosure can lead to "sadness. [Fn385] Foreclosures on subprime loans have. hard as it is on the young. especially elderly homeowners who typically have no way of earning enough money to purchase another home. Securitization. and perhaps have contributed to the recent increase in home-purchase lending in these communities. . such costs are ignored in the transaction. or the secondary cost generated by the foreclosure. like the subprime loans themselves." [Fn380] Someone who loses her house because she foolishly (or through fraud) entered into a loan she could not pay may feel great shame. . [Fn389] These foreclosure statistics do not prove that none of the subpr ime market is conducted ethically. anger. but also spreads out in a rippling fashion. it is elderly people who have lived there for many years . Once abandoned. foreclosure can lead to homelessness. [Fn381] Worse yet. The borrower typically is ill-equipped to calculate the costs of the foreclosure and so decides whether to enter into the loan transaction without adequate knowledge of the risks of foreclosure and the cost to the borrower of that risk. is typica lly fully informed about the risks of foreclosure.Held Up in Due Course: Predatory Lending. The shame itself. Their house may be the great repository of many of their life experiences and may be the Proust's madelaine to stir their most cherished memories. Lenders often seek protection from risks by charging higher interest rates or lar ger fees. and they become breeding places for crime. Because no party to the transaction adequately takes into consideration these secondary costs. with little chance of recovering any of that equity through the foreclosure process. the lender may agree to riskier loans only where the loan to value ratio for the loan is low enough that the lender can recover the full amount of its loan through the foreclosure process. or that are too frightening to contemplate. depression. 503 (2002) Page 37 now-deceased spouse.

perhaps. [Fn393] HOEPA does not cap fees or interest rates.based loan. when combined with the TILA's three day right of rescission. [Fn398] If the lender fails to provide these disclosures. [Fn392] HOEPA is an attempt to regulate high cost mortgages. 503 (2002) Page 38 ownership is due more to lending by prime banks covered by the Community Reinvestment Act than to subprime lending. [Fn391] Whatever its other effects. it is designed primarily as a method of providing additional protections and disclosures to borrowers obtaining high cost loans. as well as a statement in adjustable rate mortga ges that the monthly payments and interest rate may increase. 35 Creighton L. Among the HOEPA disclosures are the annual percentage rate and the monthly payment amounts. and the amount of the maximum monthly payment. HOEPA mandates disclosures to be given the borrower three business days before the loan is closed. [Fn400] In addition to these additional disclosures and cooling off period. and abbreviated from the regular Truth in Lending disclosures and. Securitization. which are defined in the act as those which meet one of two loan cost triggers. the borrower could lose the house securing the loan. arguing that most of such increase occurr ed between 1990 and 1995. the price paid for this increase in subprime lending so far has been the corresponding increase in foreclosures and the predatory lending that constitutes too large a portion of the subprime market. Rev. the borr ower has an extended right to rescind. HOEPA prohibits certain lending terms that have been identified to be aspects of predatory lending. an alternative loan. and if the lender fails to honor such a rescission. and creates a mandatory three day cooling off period before the consumer can commit to the loan. (b) the pr e-payment penalty does not apply to refinancing by the creditor . [Fn402] and an increase in interest rates in the event of default by the borrower. and the Holder in Due Course Doctrine. [Fn399] especially if the borrower is in bankruptcy. LEGISLATIVE AND REGULATORY RESPONSES TO PREDATORY LENDING A. which would allow the balance owed on the loan to increase rather than decrease. and also that the borrower is not obligated to enter into the loan. [Fn396] The new disclosures are in addition to. annually adjusted for inflation. [Fn394] The HOEPA provisions cover any lender that originates two or more high cost loans in any twelve month period or that makes one or more such loans through a mortgage broker. HOEPA bars balloon payments in notes with a term less than five years. [Fn397] The lender must also warn the borrower that if the borrower enters into the loan. however. or limit lenders' ability to make any form of equity. provide the consumer with at least six days to reflect on whether the loan is appropr iate. [Fn395] Once the HOEPA triggers ha ve been satisfied. or eight percent of the total loan amount (the "fee trigger").Held Up in Due Course: Predatory Lending. For example. either (a) the annual percentage rate of the loan is more than a certain percentage greater than the yield on Treasury securities with maturities comparable to the loan (the "rate trigger") or (b) the total of all the loan's points and fees payable at or before closing exceed the greater of either $400. the outcry led to the passage by Congress of HOEPA: the Home Ownership and Equity Protection Act of 1994. V. [Fn401] negative amortization. in order to prevent the lender from misleading the borrower regarding these amounts through misleading oral representations. Instead. in order to give the consumer ***Page585 time to seek advice or. the borrower may seek remedies that have been described as severe and multifaceted. HOEPA and Its Flaws After the growth of subprime and predatory lending in the 1980s. [Fn403] HOEPA also bars prepayment penalties unless all of the following conditions apply: (a) the consumer's total monthly debt payments are less than fifty percent of the consumer's monthly gross income. while subprime surged after 1995.

as they appear to be." [Fn405] This last prohibition is designed to pr event equity-based loans that seem designed to cause default by the borr ower and lead to foreclosure by the lender. any assignee of a high cost loan is subject to all of the claims and defenses the borrower could assert against the original creditor. HOEPA has been criticized for its ineffectiveness in protecting borrowers. few subprime customers have received any benefit from HOEPA's provisions.Held Up in Due Course: Predatory Lending. [Fn404] Creditors are also prohibited from engaging in a "pattern or practice of extending credit" through HOEPA loans "based on the consumers' collateral without regard to the consumers' r epayment ability. namely damages in an amount equal to all of the finance charges and fees paid by the borrower. this early criticism seems wildly off the mark. First of all. [Fn412] The liability of assignees is limited. to charge interest rates and fees only slightly below the rate and fee triggers provided by HOEPA. Under HOEPA. however. and that the interest and fee triggers were set too low. possibly as a result of less . [Fn406] HOEPA provides tha t adding a prohibited provision to a mortgage constitutes failing to deliver the material disclosur es required by Truth-In-Lending. and would drive up interest rates to them. that the mortgage was a high cost loan. Purchasers or assignees of this mortgage could be liable for all claims and defenses with respect to the ***Page587 mortgage that the borrower could assert against the creditor. [Fn415] Given the dramatic growth in the subprime market since the passage of HOEPA. essentially. [Fn407] In addition to the new disclosures and cooling off period. and therefore. unless the assignee demonstrates that a reasonable person using ordinary due diligence is unable to determine." [Fn413] Before HOEPA was enacted. anyone who assigns a high cost mortgage must include a prominent notice of the assignee's potential liability based on the consumer's retention of her claims and defenses under HOEPA. for the purposes of this article. 35 Creighton L. and (d) the penalty is not otherwise prohibited. [Fn414] Even the Federal Reserve Board criticized the proposed bill. and employment. [Fn416] Because the HOEPA triggers are set so high. Since enacted. Rev. Securitization. whichever comes first. (c) the prepa yment penalty ***Page586 no longer applies five years after the loan is consummated. allows a bor rower to rescind anytime within three years of the close of the mortgage or before the sale of the property. arguing that it would deprive borrowers of needed credit. as "§§ 1641(d)(c) and (3) limit the assignee's liability to. [Fn409] Furthermore. mortgage industry critics claimed that it would hurt borrowers by drying up the supply of credit to borrowers with checkered credit histories. HOEPA provides a limited recovery of damages for violating HOEPA's r equirements in excess of normal TILA damages. [Fn417] Anecdotal evidence indicates that the types of unscrupulous lending practices that HOEPA was designed to prevent now often occur in loans slightly under the HOEPA triggers. is the attempt in HOEPA to eliminate the holder in due course doctr ine in high cost loans. including the consumers' current and expected income. unless the creditor is able to prove that its failure to comply was not material. based on the required documentation. 503 (2002) Page 39 or its affiliates. it alone is not the basis of federal question jurisdiction where it is merely preserving state claims. [Fn408] Most significant. Should the lender violate HOEPA by inserting the barred provisions described above." [Fn411] Because HOEPA merely preserves claims r ather than creates them. current obligations. especially if lenders are willing. and the Holder in Due Course Doctrine. it has seemed too easy to evade. such a violation would trigger the extended right to rescind the transaction provided by general Truth-In-Lending la w. the greater of (1) the applicable TILA damages or (2) elimination of loan and recovery of all payments made. [Fn410] stating "Notice: This is a mortgage subject to special rules under the federal Truth in Lending Act.

[Fn419] Even yield spread pr emiums. It has been very difficult for individua l borrowers to show that lenders have engaged in a "pattern and practice" of making loans based solely on equity while ignoring the borrowers' ability to pay. Securitization. One court to address the level of proof needed to show a pattern and practice of equity-based lending has concluded that such proof would require "a representa tive sample of [the lender's] loans analyzed empirically and cannot be inferred from the examples selected by plaintiffs. the Federal Reserve Board has a dopted amendments to the provisions of Regulation Z. a lender could charge a 7. provides them with a defense against its enforcement. since the fees on the earlier loan do not apply to the determination of whether the second loan is a high cost mortgage. HOEPA still has significant shortcomings. 2002. [Fn429] It is often difficult to determine whether a particular loan is or is not a HOEPA loan. funds paid to brokers to encourage the br oker to induce the borr ower to obtain a loan at above-market interest rates.Held Up in Due Course: Predatory Lending. a servicer. accident. Rev. especially first lien mortgages packed with insurance products. as that identity may turn on whether a particular cost or charge associated with a loan should be included in the fee trigger. unless it is in the best interest of the borrower. [Fn421] Therefore." [Fn422] To alleviate these problems. without even having to wait for the term for the balloon payment to come due. 35 Creighton L. as well as other debt-protection products financed by the loan. Thus. health. The amendments to Regulation Z also are intended to reduce "flipping" by prohibiting an originating lender. [Fn426] An even less scrupulous lender can purport to abide by the HOEPA disclosur e process by backdating the required disclosures. collecting fees totaling well over 20%. while having them signed at the time the loan closes. ***Page588 Secondly. some are allegedly shifting some of their fees into such forms as credit or loss of income insurance. and the Holder in Due Course Doctrine. or an assignee from refinancing a HOEPA loan into another HOEPA loan within twelve months of the first loan's origination. Thus. or loss of income insurance. 2001 with compliance mandatory October 1. the lender obtains the primary advantage of a balloon payment. such as credit life. effective December 20. For example. 503 (2002) Page 40 scrupulous lenders shifting to the highest cost non-HOEPA loans." [Fn428] The very complexity of HOEPA. [Fn420] The limitations on points and fees could also be easily cir cumvented by more rapid flipping of the loan. seek to tighten up HOEPA by doing the following: The APR trigger for first-lien mortgage loans is r educed from ten percentage points to eight percentage points. whether a particular charge such as an appraisal fee should be . which implements HOEPA. HOEPA obviously provides the borrower no protection whatsoever. since it does not apply to the loan. [Fn427] One court noted that the failure to provide HOEPA mandated pre-closing disclosures "appears to be a prevalent pr actice in the industry. though the APR trigger for subordinate lien loans remains at its original ten ***Page589 percentage points. which have not been included in any HOEPA trigger. [Fn424] These changes should make more loans subject to HOEPA protections. These amendments.5% fee three separa te times in rapid succession for three different loans." calling this proof r equirement an "admittedly heavy burden on consumers. then contacting their borrowers after a year and suggesting that the borrower refinance the loan and obtain a new loan without a balloon payment. daunting as it may be for lenders. Lenders can avoid the effect of the limitation on short term balloon payments by writing loans with longer balloon terms. [Fn423] The fee trigger is changed to include optional insurance. lenders have been tempted to obtain additiona l profits outside of the inter est rates or fees that would trigger HOEPA. without exceeding the 8% fee trigger. [Fn418] If they do. [Fn425] While these provisions should make HOEPA more effective by including more loans under its ambit and reducing some pernicious practices. may be excluded from the fee trigger. which is the points and fees of the refinance.

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included in the fee trigger depends on whether the charge is "reasonable," which may be difficult to pin down; whether the charge is paid to a third party unaffilia ted to the creditor; and whether the creditor receives ***Page590 any direct or indirect compensation for the charge. [Fn430] All of these are factual questions that would be difficult for anyone but the lender to answer. Similarly, whether a particular prepayment fee is barred or not depends on the potentially difficult calculation involving determining the exact amount of the consumer's total monthly debt payments and monthly gross income to determine the ratio thereof. [Fn431] The complexity of these issues and the difficulty of determining whether a loan is even covered and whether certain practices are allowed or barr ed by HOEPA dra matically decrease the likelihood that HOEPA will be understood or used by private practitioners representing individual borrowers. [Fn432] Furthermore, the complexity makes it difficult for judges or arbitrators to understa nd and apply HOEPA and to enforce the protections that it is supposed to apply. [Fn433] This complexity also limits the ability of purchasers of loans to determine whether they are purchasing HOEPA loans, leaving purchasers more likely to buy HOEPA loans inadvertently. This inadvertence harms borrowers more than the purchasers, however. The assignees of the loan can claim that, because they could not determine whether the loan was covered by HOEPA, the provisions of HOEPA that would normally preserve borrower defenses do not apply to the assignees, since the assignees of the loan could not have determined, using ordinary due diligence and based on the required documentation, that the mortgage was a high cost loan. [Fn434] The very complexity of HOEPA and the difficulty of determining whether a loan is covered ***Page591 by HOEPA therefore protects the purchasers of loans at the expense of the borrowers. Most damning, perhaps, is the fact that HOEPA's effect on purchasers of a high cost loan depends on the honesty of the originator of the loan, since HOEPA does not provide liability to assignees unless they reasonably and using ordinary due diligence could have determined that the loan was in fact a HOEPA loan. The lender's determination of HOEPA status should be based on the documentation supplied by the originator and required by TILA and HOEPA, the itemization of the amount financed, and the disclosed disbursements. [Fn435] In other words, if the originator of a high cost mortgage fails to include in the mortgage a notice of potential liability to assignees and also falsifies the disclosures and disbursements so as to conceal the points, fees, or interest rate that would trigger HOEPA, then an assignee takes the mortgage free from any claims and defenses that HOEPA may have provided the borrower. HOEPA provides no protection if the disclosures hide the high cost of the loan even if, for example, the loan broker does not disburse any of the loan proceeds to the client, keeping it all for himself, as was done in the Diamond/Obie case and in the more recent Tri-Star/Polo Financial fraud. [Fn436] In the Tri-Star/Polo case, the mortgage broker, operating through a rent-a-broker, was accused of stealing the proceeds of its customers' loans and even stealing title to its customers' homes, forging documents where it would further the fraud. [Fn437] Tri-Star/Polo was accused of failing to disclose to purchasers of numerous of its loans all of the initiation, escrow, and closing fees that it charged its borrowers, thus preventing the purchasers of the loan from being able to calculate the total fees, a calculation necessary to determine whether the loans are above HOEPA's fee trigger. [Fn438] One purchaser alone may have found itself holding over $20 million in fraudulent loans generated by Tri-Star/Polo. [Fn439] Thus, the HOEPA protections are least effective where they are most needed, when a borrower is faced with an intentionally dishonest and deceitful broker and lender, ***Page592 rather than merely one who honestly charges high interest or fees. [Fn440] HOEPA primarily deters the honest predatory lender. [Fn441]

B. The Growth, Success, and Bankruptcy of First Alliance: a Post-HOEPA Predator y Lender

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HOEP A's failure, at least until the Federal Reserve Board's recent amendments to Regulation Z become mandatory, can be documented by the continuing cases of predatory lending that have occurred despite its passage. The most notable example, what has been called a "central symbol of predator y lending practices," is the rapid rise, great profitability, and unexpected bankruptcy of First Alliance Mortgage Corp., based in Irvine, California. [Fn442] First Alliance began its life as a small consumer finance lender, founded in 1971 by Brian Chisick and his wife, Sarah. [Fn443] It began growing after Congress preempted usur y limits. In 1987, the financial world was alerted to First Alliance's unseemly lending practices. That year, a jury awarded over a million dollars to an elderly couple who stated that they had been deceived into entering into three sequential loans, each demanding balloon payments, with the final loan requiring monthly payments of $400 even though the lender knew the couple's entire monthly income was $500 in Social Security payments. [Fn444] By 1988, First Alliance had become one of the five largest consumer finance lenders and ha d lent more than $65 million, according to a California deputy attorney general. In 1988, California attempted to revoke First Alliance's licenses based on allegations that it discriminated against minorities both in ***Page593 hiring and in lending. [Fn445] First Alliance was alr eady relying on aggressive direct mail and radio advertisements, according to the suit, and the state regulators sought to have that advertising stopped. [Fn446] The state also alleged that the balloon payments First Alliance used were designed to force borrowers to incur new origination fees of up to twenty-one percent to refinance when the balloon payment became due. [Fn447] The judge in the action enjoined First Alliance from engaging in discrimination, but refused either to shut First Alliance down or to force it into a receivership, as requested by the state. [Fn448] First Alliance settled the case, agreeing to pay $436,000 and to send its employees to "sensitivity training classes." [Fn449] First Alliance Mortga ge had been selling all of its loans as whole loans, but in 1989 began exploring whether it could securitize its loans to increase its profits over selling the loans individually. [Fn450] First Alliance securitized its first loan in March 1992, privately placing a $10.5 million securitization. [Fn451] In August 1993, it consummated its fir st public home equity loan asset-backed secur itization, a $56 million dollar pool of home equity loans. [Fn452] With the access to capital markets provided by the securitization conduit, First Alliance grew rapidly and, in less than a year, expanded from originating $100 million to originating $400 million in loans. [Fn453] Even as First Alliance was expanding, complaints regarding its lending practices continued. In 1994, a class action suit alleging that First Alliance fraudulently concealed its excessive and unwarranted fees from borrowers was reportedly confidentially settled, without acknowledgment ***Page594 of liability, for an amount greater than $6.8 million. [Fn454] The state of Washington investigated consumer complaints against First Alliance, including the complaint of one borrower that her loan fee was seventeen percent of her loan amount, and of another borrower that she discovered that her $59,238 loan carried an $11,632.49 fee. [Fn455] These complaints did not deter the husband and wife founders a nd owners of First Alliance, as they designed a public offering for First Alliance that apparently included plans to pay them between $43 million and $47 million of the proceeds from the offering. [Fn456] The public offering netted $59.5 million [Fn457] and the founders received a reported $45 million. [Fn458] First Alliance's retail loan origination continued growing at a scorching pace of thirty-one percent annually and, by 1997, it had twenty-five branches in places as far from its California ba se as Boston, Pennsylvania, and the United Kingdom. [Fn459] As of 1997, First Alliance had originated over $1 billion in home equity loans, made possible through securitization. [Fn460] Part of First Alliance's growth was due to its sales agents and their specialized training. According to an ex-sales agent, First Alliance hired crack used car salesmen, who were comfor table with high pressure sales

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tactics but tired of the long weekend and evening hours spent on used car lots, [Fn461] then put them through a three month training regimen, requiring the memorization and constant practice of a 134-step sales pitch, which was constantly rehearsed in front of peers and on videotape. [Fn462] The sales agents were reportedly taught to extract as much personal information as possible from potential customers, then use that information to manipulate the customer into ***Page595 agreeing to the loan, all the while attempting to hide First Alliance's high fees by such tactics as claiming that the disclosure of the fees was just "loan jargon" that the customer need not be concerned with. [Fn463] First Alliance targeted customers with significant equity in their homes, but who seemed likely, because of prior credit problems or lack of significant credit history, to have limited access to credit from conventional lenders. [Fn464] After they identified these potential borrowers, the agents hounded them with a fury, mailing over 1.5 million solicitation ads monthly, a nd using computerized dia lers to solicit targeted homeowners, often the same ones over and over, as well as the company's existing borrowers. [Fn465] Worse yet, First Alliance has been widely accused of engaging in outright deception and openly lying to its customers about the amount of fees it would charge them and the amount of the loan that would encumber their homes. In one case, a homeowner reportedly recorded a First Alliance sales agent who expressly lied to her, and when she asked him if there would be $13,000 in fees added to her loan of about $46,000, the loan agent replied, "No, no, no" even though "the answer should have been 'yes, yes, yes." ' [Fn466] The sales agent, when interviewed, said he was merely following the script First Alliance taught him to follow, according to published reports. [Fn467] Using high pressur e, allegedly deceptive sales tactics allowed First Alliance to charge sales fees of reportedly up to twenty-three percent of the loan amount, even though the industry wide standard was about five percent. [Fn468] First Alliance was said to have had charged the same high fees whether the borrower had good or bad credit, demonstrating that its sales tactics had succeeded in allowing First Alliance to ignore the market rate for the credit it was supplying. [Fn469] First Alliance's fees were "just so excessively high that it's hard for me to conceive of any way a consumer would agree to that kind of loan if all the ***Page596 facts have been put before them," asserted a Florida assistant attorney general. [Fn470] In 1997, First Alliance was sued for allegedly defrauding several elderly (and some less elderly) homeowners through trickery, including a suit by a seventy-six year old woman who alleged that she wanted only a $5,000 loan for plumbing repairs, only to find herself saddled with two loans totaling more than $61,000 with $16,000 in fees after the loan broker covered up parts of the documents and failed to make proper disclosures to her. [Fn471] At about the same time First Alliance was being sued and receiving increasingly widespread newspaper reports of its disreputable lending practices, [Fn472] First Alliance reported that its net income for the first six months of 1997 was $15.6 million, a 54% increase over the year before. [Fn473] Despite the bad press and lawsuits, First Alliance was able to sell its mortgages through repeated securitizations [Fn474] and, in early 1998, it was touted by stock analysts as a "tightly run ship" and praised for its conservative approach and sound fundamentals. [Fn475] When criticized for charging its customers excessive, unconscionable rates, First Alliance defended itself by claiming that the low credit ratings of its borrowers made loans to them risky, and that it had to char ge them high rates to cover that risk. At the same time, however, in documents that it prepared for investors in its securitized loans, First Alliance reportedly averred that over three-fourths of its loans are made to borrowers with relatively good credit records. [Fn476] ***Page597 The first significant chink in First Alliance's armor appear ed in May 1998, when the American Association of Retired Person ("AARP") joined in a $50 million lawsuit accusing First Alliance of targeting elderly homeowners and using aggressive telemarketing and direct mail advertising, along with

First Alliance announced it would begin a web site to lend on-line. [Fn485] Despite First Alliance's efforts to limit the effectiveness of borr ower litigation against it. [Fn487] In late 1998. reportedly ruled that the signatur es of an elderly couple on a form waiving the right to file lawsuits had been "obtained by fraud" and said that First Alliance had "trained its employees to use various methods. a California court of appeals. [Fn481] Therefore. and of showing that First Alliance engaged in widespread conduct similar to that alleged by the individual borrower. knowledge of that loss was much less likely to reach the investors in First Alliance's securitized loans. to sell its services. arbitration often limits the ***Page598 amount of discovery that a party ca n conduct. First Alliance's income for the year was still an astonishing $484 million. including its affiliated organizations. it announced that it had settled the action by the State of Minnesota for $550. and the arbitration is unlikely to result in a published opinion. [Fn484] Finally. in an unpublished opinion. arbitration typically proceeds privately. the lawsuits and publicized allegations of dishonest lending finally began to affect First Alliance. [Fn478] First Alliance attempted to defend itself from litigation by inserting a mandatory arbitration clause into its lending contracts. before First Alliance announced that the Justice Department and seven attorneys general had opened investigations of its lending practices." [Fn492] In March 1999. preserving First Alliance's access to the secondary market. only $50 million less than during 1998. [Fn494] In September 1999. [Fn486] In November 1998. [Fn493] In June 1999. charging it with deceptive practices. First Alliance. 35 Creighton L. in order to strip the elderly homeowners' equity from them. dropped to less than $3 in interday trading in October 1998. [Fn496] By 1999. [Fn477] Sharp lending practices had apparently become a family business. serviced nearly $900 million in loans and had licenses in . [Fn490] An industry publication anticipated that securities backed by First Alliance's notes would be rated AAA by two rating services long after any knowledgeable observer should have been well aware of the extensive allegations of fraud and deception by First Alliance in creating its pools of loans. even if First Alliance were to lose the arbitration. [Fn491] In Februa ry 1999. Securitization.Held Up in Due Course: Predatory Lending. [Fn488] These suits were followed by a nationwide class action accusing First Alliance of ***Page599 hiring former used car salesmen to pressure its borrowers to accept loans with hidden fees and "exploding" interest rates. Minnesota sued First Alliance. effectively preventing borrowers from proving that First Alliance had a pattern and practice of lending to borrowers without a reasonable likelihood of the borrower being able to repay the loan. [Fn489] Despite all of its well-publicized legal problems. Rev. arbitration clauses make class action suits much more difficult to prosecute. 503 (2002) Page 44 concealing loan amounts to coerce borrowers into entering into loans with origination fees that averaged approximately fifteen percent of the loans. appeals are severely limited.000. including intentionally trying to hide its unconscionable fees and monitoring borrowers' conversations through hidden microphones after the First Alliance agents had left the room. since it would not have access to a published opinion to learn the result of the arbitration. [Fn479] Such arbitration clauses helped First Alliance in several ways. Massachusetts and Illinois also sued First Alliance based on allegations it intended to deceive borrowers regarding its high fees. as two loan brokerage companies owned by three sons of founder Brian Chisick were investigated by Washington and Oregon regulators to examine allegations of deceptive lending practices. First Alliance's parent corporation announced that First Alliance had completed a $115 million securitization. successfully completing a securitization of $120 million in mortgage backed loans in December 1998. First Alliance continued to securitize its loans. [Fn495] Despite its legal problems throughout 1999. [Fn482] Secondly. Its stock. [Fn480] First of all. [Fn483] Arbitration clauses would also make it much more difficult for one homeowner to employ offensive collater al estoppel and attempt to use in one case a finding in a separate case that First Alliance's methods constituted fraud. which had traded at over $24 per share in late 1997. including deception. and the Holder in Due Course Doctrine.

By protecting the secondary market investors from liability for purchasing First Alliance's loans. 503 (2002) Page 45 eighteen states and the District of Columbia. § 226. it has allegedly failed to provide timely HOEPA disclosures to at least some of its . in one bankruptcy ruling. [Fn498] apparently trying to justify the more than $2 billion in loans by First Alliance that Wall Street firms had securitized. According to published reports.C. §§ 45(a) and 53(b). and the Holder in Due Course Doctrine. First Alliance successfully engaged in its predatory practices despite the protections of HOEPA in two ways.S.S. and Regulation Z. the bankruptcy petition may have been part of a strategy by the company to stymie the litigation against First Alliance while protecting the value of the corporation to its shareholders. [Fn512] As of the time of this writing. Because of its former great pr ofitability. Securitization. a Lehman executive writing of First Alliance. [Fn508] As a result of First Alliance's bankruptcy. 15 U.F. [Fn503] First Alliance's founder claimed that the filing was due to the "unfa ir and inaccurate stories [that] have devastated the company's 30-year reputation and acutely hindered the company's relationships with businesses. [Fn497] Even in early 2000. [Fn500] In private memos. at which First Alliance was represented by a nationally prominent law firm.R. [Fn510] The judge also barred the prosecution of class action lawsuits against First Alliance. given First Alliance's apparent assets and the information that had been provided to them. consumers and regulators. 35 Creighton L. First Alliance has reportedly settled many of the claims against it for either $60 million or $95 million without admitting any wrongdoing. based on alleged fraud and violations of a Florida unfair business practices statute. First Alliance pierced this balloon. has been able to hire the most exper t and capable legal representation. the settlement encourages further investment in loans originated by shady originators. First Alliance. For example. § 1607(c). these rulings were overturned by a federal district judge. the second in October 2000 by the FTC. 2000. the borrowers were ***Page602 required to waive their right to cancel their outstanding loan.Held Up in Due Course: Predatory Lending. Lehman appar ently had a different view of First Alliance. eliminating in a stroke hundreds of millions of dollars in claims against the bankruptcy estate of First Alliance. rather tha n being a sign of current financial distress. [Fn505] Some have speculated that. Rev. as part of this settlement. [Fn509] This legal talent for a time had significant success in defending First Alliance from class claims by borrowers.C. either based on borrowers' damages or First Alliance's unjust enrichment. the borrowers it victimized are unlikely to collect much for the harm they received. [Fn514] Despite the funding they provided First Alliance. [Fn506] ***Page601 After First Alliance filed bankruptcy. by the state of Florida against First Alliance and some of its officers and employees. [Fn507] Both suits sought rescission of homeowners' loans and disgorgement of money. [Fn502] On March 23. the federal Truth in Lending Act ("TILA"). based on alleged violations of the Federal Trade Commission Act. and threw out AARP's action against First Alliance based on California's unfair and deceptive practices law. [Fn511] Later. First of all. " [Fn504] This bankr uptcy filing may have come as a shock to the investors in First Alliance's securitized loans. to defend itself from its victims' claims. announcing that it had stopped making new loans and that it had filed bankruptcy under Chapter 11. which implements TILA." [Fn501] Lehman helped First Alliance securitize its loans even though Lehman reportedly acknowledged that it was fully aware of First Alliance's legal problems. it appears that the investors in the mortgage pools will be able to retain their interest in the loans originated by First Alliance and the excessive interest rates that the loans generate. 15 U. [Fn499] Lehman's spokesman claimed that Lehman officials somehow believed that First Alliance had improved its efforts during the last eighteen months to prevent lending abuses. 12 C. a spokesman for Lehman Brothers defended First Alliance's lending ***Page600 practices. at significant expense. [Fn513] According to published reports. the bankruptcy judge refused to allow class proofs of claims on behalf of certain borrowers. even in the midst of bankr uptcy. stated "It is a requirement to leave your ethics at the door. two more governmental actions were filed against it: the first in June 2000. and Lehman's involvement with First Alliance.

Held Up in Due Course: Predatory Lending. and high priced credit insurance. by the close of the 106th Congress. costs and fees. which would deny them the additional time to investigate the loan and discover its terms before being bound by the loan. was charged by the FTC in 2001 with actively misleading borrowers in order to induce them into accepting loans with high interest rates. including an estimated one percent falling under the APR trigger. [Fn522] First Alliance is hardly alone among leading subprime lenders in its use of predatory lending tactics. prevents borrowers from seeking recovery either from the predatory lender or from the purchaser of the loans. They hid essential ***Page604 information from consumers. the ratings agencies and underwriters may have concluded initia lly that they did not need to exclude HOEPA loans fr om securitizations or treat them much differently than non-HOEPA loans because there were so few of them. directory of the FT C's Bureau of Consumer Protection. [Fn518] Therefore. misrepresented loan terms. Securitization. most of the leading subprime lenders have filed for bankruptcy since the great liquidity crisis of October 1998. [Fn519] Given the huge profit that Wall Street was making on the securitization of subprime loans. flipped loans and packed optional fees to raise the costs of the loans. in violation of the Federal Trade Commission Act. [Fn527] C. [Fn517] This laxity may be explained in part by the low percentage of all subprime loans HOEPA affects. 35 Creighton L. . alleging that it is liable for First Alliance's wrongdoing. [Fn525] In September 2001. 503 (2002) Page 46 borrowers. [Fn515] Secondly. turned a blind eye to the problems potentially associated with securitizing HOEPA loans. Rev. [Fn520] It appears that only by holding the securitizers and purchasers of the loans generated by a predatory lender liable for the harms caused by that lender's activities can those investors and securitizers be convinced to stop dealing with unscrupulous lenders. Citigroup Inc. Lenders have not been required by law to disclose to a rating agency or securitizer how many HOEPA loans are included in a particular loan pool. [Fn516] Until recently. as well as . intentionally or unwittingly. four separate bills designed to combat predatory lending (one introduced separately in the House and the Senate) were referred to committee. underwriters and rating agencies have been surprisingly lax about determining how many HOEPA loans are in a pool. the secondary markets were not as attentive as they should have been to how many HOEPA loans a particular lender was securitizing. Wall Street's attention has been captured. A lender's ability to evade liability for fraudulent or deceptive conduct through bankruptcy." [Fn524] Associates was acquired by Citigroup in 2000 for about $31 billion. separate from the FTC action. given Lehman's participation in Fir st Alliance's securitization of loans. and the Holder in Due Course Doctrine. reportedly agreed to pay up to $20-million to settle a claim brought by the North Carolina attorney general. . the firms may have. [Fn526] The FTC began actions against fifteen different subprime lenders from 1998 through mid-2001. given that the presence of HOEPA loans is an indication of potential predatory loans and that the holders of HOEPA loans do not have holder in due course protection. In fact. leaving a vast number of subprime borrowers without any remedy for fraud or deception. [Fn528] At least thirty-one states. however. [Fn523] Jodie Bernstein. by a class action lawsuit against Lehman Brothers." the FDIC does not advise banks to determine how many HOEPA loans are in a mortgage pool before investing in securities related to that pool. State and Local Efforts to Patch HOEPA HOEPA is fa r from the only legislative or agency response to predator y lending. [Fn521] Like First Alliance. when combined with the holder in due course doctrine. Associates First Capital Corporation. ***Page603 some participants in the secondary market may not have realized that HOEPA actually eliminates the holder in due course doctrine in high cost loans. Also. Even in its November 2000 draft memorandum on "How to Avoid Purchasing or Investing in Predatory Mortgage Loans. as late as last year one of the nation's largest subprime lenders. . claimed that "The Associates engaged in widespread deceptive practices .

[Fn535] but this claim appears to be wildly exaggerated. a widely varying mosaic of laws and ordinances designed to combat predatory lending can drive up the cost of borrowing by charging the lender with the task of keeping track of not only the federal rules. [Fn547] Most importantly. have introduced varied bills seeking to rein in predatory or improper lending. By comparison. Rev. [Fn529] North Carolina became the first state to enact a statute attacking predatory lending. [Fn544] No doubt. [Fn531] Even Fannie Mae announced loan purchase guidelines designed to combat predator y lending. ***Page606 Perhaps more importantly. and may make it more difficult to securitize even legitimate. such as barring. even within the first three years. prohibiting flipping and limiting brokers fees. abrogating the holder in due course doctrine as to this . non. Some lenders are claiming that local action to attack predatory lending will cause lenders to forego making subprime loans in such jurisdictions entirely. the ordinance specifica lly applies not only to the originators of the note but also to any assignees or purchasers. which is the directing of borrowers to loans that have higher costs than other loans the borrower would be eligible for. unless an independent counselor has determined that the borrower ***Page607 would be best served by such a refinance. [Fn542] Among the remedies the Act supplies is the ability of a court to reform the note to remove any barred term. [Fn541] and loan steering. [Fn536] In addition. a statute that goes beyond HOEPA by. and the Holder in Due Course Doctrine. [Fn546] The ordinance is even stricter regarding high-cost loans. and barring lenders from financing credit insurance and from encouraging a borrower to miss a payment on an existing loan. as defined by the ordinance. may not charge any prepayment penalties on high cost mortgages. Securitization. given the obvious flaws in HOEPA. [Fn534] This critic notes that this would be especially true if the penalties for predatory lending are severe and local standards defining "predatory lending" are so vague that a lender cannot reasonably determine whether the loan it is considering funding is in fact predatory. California recently passed a bill designed to curb predatory lending. the other rules that might prevent such lending. or the steering of borrowers by mortgage brokers to lenders who would charge the borrower more than would other lenders with whom the borrower does business. and the City of Chicago.predatory subprime loans. but also on any potential assignees of the loans. and so would argue tha t a court could not order reformation of a note under the Act once the note is held by a holder in due cour se. among other things. among others. may not refinance any loa n with a high cost loan unless the borr ower receives a benefit. the lending industry may attempt to use some anti-predatory lending law to weaken. and in fact would require an easily updated web page to avoid being out of date nearly instantaneously. the Oakland City Council passed a much tougher ordinance to deter predator y lending. [Fn537] This bur den would be imposed not only on the original lender. and cannot refinance a subsidized or below market rate loan with a high cost loan. purchasers of predatory loans will claim to have taken them free of any claim based on this Act. limiting the amount of prepayment penalties. at least one critic has argued that too many forms of lending regulation could drive up the cost of credit and harm the very low income borrowers the regulation is intended to help. Lenders may not make high cost loans without receiving a certification that the borrower received home loan counseling. [Fn538] California's Act does have some good features. [Fn530] North Carolina has since been joined by Massachusetts. prepayment penalties after three years from the loan's origination. [Fn532] A full description of the numerous proposals to attack ***Page605 predatory lending currently in play is outside of the scope of this article. and states where the lender does business. [Fn533] This plethora of legislation and ordinances is obviously well-intentioned. [Fn543] The Act's main defect is that it accomplishes too little and explicitly does not apply to holders in due course. rather than strengthen. However.Held Up in Due Course: Predatory Lending. counties. for loans covered by the bill. [Fn539] negative amortiza tion for junior loans of any duration. 35 Creighton L. [Fn540] loans made with no expectation that they can be repaid. [Fn545] This ordinance bars some practices on all loans in general. For example. New York. 503 (2002) Page 47 numerous cities and counties. but also the various rules in the many cities.

35 Creighton L. patchwork response to the problem. And they are employing high pressure sales tactics. it takes too much time for the regulator or prosecutors to discover that a particular broker or lender is engaging in fraudulent practices. though helpful. 503 (2002) Page 48 ordinance. Only the purchasers of the loans have the ability. VI. the secondary market and the Wall Street secur itizers are dealing over and over with the same particular shady originators of the credit instruments. At the same time. Rev. Securitization. they are promising goods or services that are either never delivered or are delivered in a way contrary to the representations made to the borrower. to prevent its ordinance from being enforced. a lender trade association has sued Oakland. which is that the buyers of predatory loans bear too little risk of loss for fraud and misrepresentation committed by the originators of those mortgages. Now. however. described below. Actions by regulatory agencies or prosecutorial bodies. enjoin the behavior. [Fn549] The association is attempting to use weaker state law to defeat stronger local law. then selling their credit instruments to finance companies. The surest solution to the problem of predatory lending is to force the markets that fund subprime lenders to police those lenders. and the Holder in Due Course Doctrine. There is a similar victimization of consumers by fly-by-night dealers who immediately assign their credit instruments to other business entities. or prosecute the lender criminally. rather than having that loss borne by the borrower. mortgage brokers are tricking borr owers into signing overpriced and inappropriate loans. Too many mortgage brokers have adopted the sleazy techniques of used car salesmen or fly-by-night home improvers. then even more time to gather the evidence and engage in the due process required to strip the lender of its licenses. Courts are giving individual relief to some borrowers but cannot create uniform rules that pr otect all borrowers. even going so far as to hire the used car salesmen directly. are too slow. then selling those loans to securitizers. Diamond/Obie and Polo/Tri-Star. cited supra. and outright fraud. the sta tes and local governments have developed an increa singly complicated. only to claim ignorance of the originators' fraud and to rely on the status as holder in due course as protection for their ***Page608 investors when the borrower objects to the deceit and unfair practices used by the originators. [Fn550] Cour ts and legislatures have responded to predatory lending much as they did to predatory home improvers and retail merchants. [Fn553] . and the surest way to force this private policing effort is to ensure that the buyers of predatory loans bear any risk of loss associated with the sharp practices by the lender. THE CASE FOR ELIMINATING THE HOLDER IN DUE COU RSE DOCTRINE FOR ALL NON-COMMERCIAL LOANS With the rapid growth in subprime and predatory lending and the securitization of subprime loans. [Fn551] These local responses. the subprime industry greatly resembles the consumer credit industry of the 1970s before the FTC eliminated the holder in due course doctrine for that industry through its regulation. do not address the core problem. just as states once acted independently to stop fraudulent retail credit practices before the FTC stepped in. to create an early warning system to detect the presence of improper loan practices and to stop the brokers responsible by cutting off the brokers' supply of funds available to close any additional loans. as it can take months if not years before a regulatory body even notices a mortgage broker's deceptive practices. Like their dishonest predecessors. misrepr esentations. arguing that the ordinance is preempted by state law. [Fn548] In response to the Oakland ordinance. Now.Held Up in Due Course: Predatory Lending. The FTC acted because finance companies cla imed holder in due course status even though they bought retail installment contracts regula rly from the same unscrupulous contractors and merchants. instead of home improvement contractors fleecing customers with shoddy siding. [Fn552] As demonstrated in the cases of First Alliance.

the creation of the negotiable instrument could still be efficient if judged by the less rigorous standard of Kalder-Hicks efficiency. 35 Creighton L. she should know how the risk of loss would be assigned if. or at least not cause them any harm. as well as the costs of additional precautionary measures the borrower would have to undertake because of the assignment of risks. which demonstrates that this doctrine is inefficient when applied to non-commercial loans. [Fn557] Whether an instrument is negotiable is an important element of the value of that instrument to the maker. especially a subprime borrower concerned about predatory lenders. [Fn555] If third parties are somehow harmed. and those agreements may cause more harm than good. each transacting party should have sufficient information to determine the value of the creation of the negotiable instrument to that party. what its legal effect would be. would benefit them. for example. and because it discourages the actors most able to prevent loss caused by a dishonest loan originator fr om engaging in the loss-prevention monitoring that is needed to prevent predatory lending. and the Holder in Due Course Doctrine. 503 (2002) Page 49 Because the best way to encourage the purchasers of loans to cut off the predator y lender's supply of capital is to force those purchasers to bear the risk of the fraudulent or misleading practices of that lender. unless third parties are somehow injured by the creation of the negotiable instr ument. The borr ower would need to factor in the risk assigned to him. Indeed.Held Up in Due Course: Predatory Lending. [Fn554] If this transaction benefits each of its participants or least benefits some and does not har m the others. then the tr ansaction would be efficient. the more commonly applied standard that would require only that the benefit to the transacting parties exceeds the detriment to any third parties. [Fn556] To determine whether creating the negotiable instrument would benefit them. to determine the assignment of risk and the resulting costs of the loan to the borrower. they cannot make sure that they will enter into only loan agreements that benefit them. because it prevents borrowers from effectively determining the cost of their loans. or at least leaves them no worse off. A. the transaction would meet the more rigorous standard of Pareto Superiority. and the magnitude of the risk of fraud or loss that it assigns are all essential pieces of information for any borrower. Securitization. either in interest rate or other terms. The Holder in Due Course Doctrine Is Inefficient Because It Prevents Informed Decision-Making by Borrowers The holder in due course doctrine is inefficient and harms borrowers by making it more difficult for them to determine whether a particula r loan is in their best interest. given that any defenses he might acquire based on those repr esentations could be almost immediately cut off if the other party transfers the instrument. Before a borrower enters into a loan. which is satisfied if a transaction benefits every party affected by it. neither the drawer nor the payee of the negotiable instrument would likely engage in the creation of that negotiable instrument unless each believed that the creation. such as residential mortgages. The effectiveness of this elimination can be seen through an economic analysis of the holder in due course doctrine. she did not receive the . Only if the borr ower understa nds this risk and the attendant costs will the borrower know what terms he should demand. which would require each party to be reasonably ***Page610 well informed regarding the potential benefits and costs before making the exchange. [Fn559] Whether the holder in due course doctrine applies to a particula r loan. If borrowers are unable to understand how the holder in due course assigns risk. in order to insure the loan will actually benefit him. Assuming that each party is acting in his or her own self-interest. the problem of predatory lending calls for the elimination of ***Page609 the holder in due course doctrine in all loans secured by residences of the borrowers. [Fn558] Understanding the assignment of risk will also help the borrower determine to what extent he should discount any representations made to him by the originator of the loan. Rev. producing a net good. including its attendant transaction costs.

The holder in due course doctrine effectively prevents borrowers from obtaining this information. fraud. especially on a broad scale.Held Up in Due Course: Predatory Lending. is a ll too likely to declare bankruptcy or simply disappear. in that it would not occur to the aver age bor rower that her legal rights could be affected by the lender merely assigning her loan. Either case causes a loss. or misrepresenta tion. or the loan is substantially different than it was represented to be and the homeowner is induced into entering into a loan that does not make economic sense for him to have entered.' 'cash' or 'exchange. the latter a loss of the more beneficial terms the borrower could have obtained had no fraud or misrepresentation been involved. the primary question is who should bear the loss. or conversion. Next. and the Holder in Due Course Doctrine. but any mortgage broker or lender who commits theft.' 'order. and risk assessment. a borrower would first have to understand that a gap-filling term not in the contract but instead provided by operation of law could determine whether the borrower or the purchaser of the loan bears the risk of loss caused by a lender's dishonesty. [Fn562] Consumers are little used to contracts that assign them the risk of loss due to the fraud of a seller. Next. unless he can demonstrate one of the so-ca lled "real defenses. 35 Creighton L. the borrower would have to understand when the holder in due course doctrine is abrogated." ' [Fn560] The holder in due course doctrine is not only little known by non-commercial borrowers. Rev. and so would not expect that the loan agreement would do so. [Fn566] Once this loss has occurr ed. As noted by Lary Lawrence." [Fn564] is clearly beyond the capabilities of all but a minute fraction of non-commercial borrowers. it is unfairly difficult for them to learn and understand. . Clearly. the first the loss of the proceeds of the loan. [Fn563] To understand the holder in due course doctrine and its potential effect." Then. The Holder in Due Course Doctrine's Assignment of Risk Encourages Fraud Another way to consider the effect of the holder in due course doctrine is to think of it not so much as a negotiation issue. This kind of understanding. leaving insufficient assets to make its ***Page613 victims whole. or by the FTC Holder in Due Course Rule. 503 (2002) Page 50 mortgage proceeds because of a dishonest broker's conversion. One of the pr imary purposes of the holder in due course doctrine is to allocate the risk of loss between the maker of a note and the buyer of the note from the original lender. [Fn565] Non-commercial borrowers are bound by that negotiability. "No one except a student of Article 3 would know that the difference between a non-negotiable and a negotiable ***Page611 instrument is the use of a magical word like 'bearer. because it is so little known. [Fn567] Therefore. regardless of their ignorance of it or the harm that it might ca use them. A typical loss in the home mortgage market occurs when the loan is the product of fraud or forgery. ***Page612 but without such understanding. by HOEPA. misrepresentation. or par t of the formation of the contract. [Fn561] The holder in due course doctrine is counter-intuitive. information gathering. the doctrine's "cognitive load. which would require an assessment of the likelihood of the lender engaging in sharp or dishonest practices and the potential harm that those practices could ca use. Securitization. the borrower would have to determine the amount of risk that the holder in due course doctrine is likely to assign. the borrower would have to realize that the holder in due course doctrine assigns such risk of loss to him. but rather as a question of how to allocate certain types of loss caused by fraud. for example by TILA. subprime borr owers dealing with under-regulated mortgage brokers are likely regularly to enter into loan agreements embodied by negotiable instruments that harm rather than help them. the mortgage broker or initial lender who converted the proceeds of the loan or who committed the fraud or misrepresentation that caused the loss should bear the loss. however. B. such that either the homeowner does not receive the proceeds of the loan.

against the assignee of the loan that he would against the original lender. Rubin point out that the principle of loss reduction can itself be divided into four elements: precaution. insisting on dealing only with reputable brokers and lenders and ones with sufficient capital to cover sizeable losses. Securitization. responsiveness. and learning. 503 (2002) Page 51 the loss must be allocated between the borrower and the purchaser of the loan or subsequent holders. [Fn573] To maximize effective precaution. We should try to allocate the loss to the party that can most inexpensively and easily prevent or minimize the loss. Effective Precaution: Borrowers vs. Rev. The Secondary Market Precaution consists of the steps that parties can take to avoid or minimize the loss before the loss happens. But how can we determine whether the losses are allocated efficiently? The most effective way. several factors can affect how the risk of loss should be allocated. loss activity assignment. some risk of loss should be assigned to all parties who can take precaution. under the holder in due cour se doctrine. refusing to sign those that she does not understand or agree to. [Fn574] However. The Failure of Effective Loss Reduction Under the Holder In Due Course Doctrine Loss reduction is the most obvious and easily understood of these loss allocation principles. perhaps. then less risk of loss should generally be assigned to that party (the risk sensitive party). then generally ***Page615 more of the risk of loss should be assigned to that party (the more efficient precaution provider). loss responsiveness. Cooter and Edward L. try to deal only with reputable loan brokers and to read all of the documents presented for her signature. [Fn578] . For the holder in due course doctrine to work effectively. the borrower loses all defenses except the so-called "real defenses. They can also monitor the complaints and default rates of loans that they have already purchased. and a rule works efficiently when it prompts each par ty to underta ke precautions that will cost less than the costs that will occur if the party fails to take such precaution. In the absence of the holder in due cour se doctrine. and loss spreading." [Fn568] Therefore. This allocation of loss would give the greatest incentive to reduce the loss to the party most able to reduce the loss efficiently. including fraud or theft. the loss should be borne by the assignee of the loan since the borrower would be able to assert any defenses. 35 Creighton L. However. Robert D. therefore. [Fn576] This factor. for the most part the holder in due course doctr ine places the risk of loss for most fraud firmly on the back of the homeowner who signed the note. Both the borrower and the purchaser of the loan can take precautionary steps: the borrower can refuse to respond to subprime lenders' advertising. with each party obtaining at least sufficient risk of loss to encourage them to take the most cost-effective amount of precaution. [Fn577] The purchasers of loans or securities backed by residential mortgages can investigate the brokers and lenders from whom they buy loans. [Fn575] Similarly. and the Holder in Due Course Doctrine. they will be addressed here together. innovation. [Fn569] One can divide the efficiency of loss alloca tion into four major principles: loss reduction. or do not correspond to the oral representations she has received. [Fn572] Because loss responsiveness and learning are so closely related and affect each other. will be discussed in section VI(C)(3) infra. is to break "efficient" loss allocation down into its constituent parts and then test the holder in due course doctrine against each part. where one party is much more sensitive to risk and requires a much smaller risk to induce a party to maximize its precaution. Where one party ca n take more effective precaution at a lower cost. [Fn571] C.Held Up in Due Course: Predatory Lending. 1. ***Page614 loss imposition. it must be an efficient system of allocating these losses. [Fn570] The most efficient system is one that best balances these principles. and refuse to deal further with brokers and lenders where there have been problems.

The cost to the secondary market of such monitoring would be two-fold. could easily come to naught. as even the largest subprime lenders such as First Alliance have been accused of fraud ***Page616 and deception in making subprime loans. would be more effective at less cost. [Fn585] They can conduct complex analysis of loan pools to see which loans and which lenders are likely predatory. [Fn579] Nor are the borrower's efforts to avoid deception by reading the loan documents carefully likely to bear fruit. By comparison. balloon payments or prepayment penalties with no corresponding decrease in interest rates for borrowers. be driven out of business. precautionary measures simply by refusing to deal with originators who develop a reputation for sharp practices or deception or who regularly engage in predatory pricing of their mortgage products. The secondary market has effective tools to discover predatory practices and refuse to purchase the loans that result. although they cannot prevent a particular predatory loan from being made. as the documents are so complex and confusing for the borrower that an unscrupulous lender can easily insert unfair terms in the loan agreement without the borrower's knowledge. the secondary market has by far the most cost effective means of . 35 Creighton L. 503 (2002) Page 52 On the surface. [Fn583] They can identify specific "hot zones. it is clear that the borrowers' attempts at precaution can be feeble at best. it is a cost tha t is a lready being incurred to good effect by some members of the mortgage industry. reputable lenders. [Fn584] Lenders and underwriters have the help of federal regula tors to advise them how to discern warning signs of predatory lending. Lenders and underwriters can use sophistica ted databases that track fraud and other suspicious activity in residentia l mortgages. A subprime borrower's efforts to avoid deceptive loans by dealing only with large. for the most part. that securitizer's action does not prevent the originator from attempting to sell the loan elsewhere or attempting to collect on the loan itself. and the fruits of that labor can be easily shared with little net cost to the entire lending industry. Rev. it appears that the borrowers' precautionary measures. the loan would not exist to begin with. If such disreputable lenders lose their access to the secondar y market and are forced to keep their loans themselves and attempt to collect from their own. these unscrupulous originators would. [Fn581] much of the complexity of the transaction is inherent in any loan secured by real property. [Fn587] Because the essence of pr edatory lending is charging above the market rate for loans. as the presence of a security interest necessarily complicates the transaction well beyond the understanding of most residential borrowers. If a potential borrower refuses to sign an unfair or fraudulent loan then. long-term. given the credit risk of the borrower. given the size of the subprime market and that it can be spread out over the entir e market. absent forgery. first of all. [Fn586] Participants in the secondary market can review loans for signs of unscrupulous tactics. Therefore. their escape will not prevent unscrupulous lenders from moving on to their next victims. the costs of acquiring information about which brokers and other originators are suspected of illegal or improper practices. the secondary market participants can spot evidence of predatory lending by comparing the borrowers' credit scores with the loan costs to see if the borrower was overcharged. The former cost is not an undue one. often angry. the secondary market can take effective. identifying questionable brokers by name. Securitization. including excessive fees and interest rates. and the Holder in Due Course Doctrine. while the buyers of loans on the secondary market.Held Up in Due Course: Predatory Lending. borrowers who retain their defenses to the loan. can take inexpensive yet effective measures to reduce the general incidence of unfair loans. [Fn582] While the rare borrowers so sophisticated that they understand all the terms of the loan may escape fraud. because they are so direct. and adjustable rate loans that only increase. and secondly the cost of foregoing the profits to be gained by buying predatory subprime loans that have interest rates above the market rate. This latter cost is not one that ***Page618 even Wall Street is likely to publicly decry." neighborhoods ***Page617 that contain an unusually high incidence of residential foreclosures and are likely breeding grounds of predatory lending. On closer examination. however. If a loan securitizer refuses to purchase an unfair loan from a dishonest originator. [Fn580] While some blame this complexity on the mandated mortgage disclosure forms. More importantly.

[Fn588] This concept causes the element of precaution to be viewed as a dynamic. [Fn593] These separate aspects of comprehension may not reside in the same party. changing system. a borrower would have great difficulty in assembling the tools to track preda tory lenders. while a neophyte. than non-repeat. including legislative reforms.Held Up in Due Course: Predatory Lending. 503 (2002) Page 53 precaution at its disposal and for this reason. should be assigned more of the risk of loss than the borrower. risk should be assigned to parties who will realize that they bear the risk. This knowledge is not static. If she does not appreciate the amount of risk. then she will be unable to determine the appropriate precautions to take. they can spread the costs of all of these innovations among many of them or among the entire industry. then assigning the risk to them would do more to prevent the loss than assigning the risk of loss to an unresponsive party. Securitization. or to encourage the spreading of the cost of that enterprise to other borrowers. even if the cost of preventing the loss might be lower for the unresponsive party. 2. or even a group of borrowers acting en masse. can create new methods or mechanisms for consummating the transaction that will minimize the risk of loss. A party's responsiveness to the assignment of risk depends on whether the party understands that the risk has been assigned to them and on whether the party recognizes the magnitude of the risk. [Fn589] Investors and the other commercial players are also likely to be the only parties with the attorneys. If some parties would take effective precautions and so prevent the loss. [Fn591] An individual borrower. ***Page619 3. then the risk of loss should be assigned to the parties that will likely change its behavior. Innovation and Loss Reduction The element of innovation asks which party. Rev. one party might better understand the magnitude of the risk. lobbyists. yet have no effective way of discovering the magnitude of the risk. Fur thermore. [Fn590] Finally. if they will not change their behavior or act to reduce the risk of loss even if the risk of loss is assigned to them. Another party may recognize who is assigned the risk by action of law. would not likely be allowed to change even the wording of the note and deed of trust. and the Holder in Due Course Doctrine. Therefore. if forced to bear the risk of loss. private players because the commercial players have an interest in improving a process in which they will engage for decades. yet not realize that the law assigns the entire r isk to him. one-time player has little reason to care about the process other than its effect on the single transaction at hand. then she is much less likely to be responsive to it. financial expertise. In other words. If the borrower somehow did attempt to innovate any aspect of the lending process. and planning ability to make any innovation in the financial services sector. that attempt would almost certainly fail as the securitization process requires standardization. both in terms of how large the loss might be and also in terms of the chance of the loss occurring. [Fn594] If a party does not understand that the risk has been assigned to her. The Unresponsiveness of Borrowers to the Loss Assigned by the Holder in Due Course Doctrine Determining whether parties will be responsive to liability rules and to what extent is crucial in determining whom should be assigned the risk of loss. Repeat commercial players are far more likely to engage in innovation. the purchasers of the note. and to the parties most able efficiently to evaluate the risk and determine the probability and amount of the loss. [Fn592] Even if borrowers were the lowest cost reducer of mortgage fraud. They can also create innovative systems to discover and track unscrupulous mortgage brokers. 35 Creighton L. since the parties might well be able to .

and thus prevent borrowers from becoming more knowledgeable about the loan. [Fn596] The holder in due course doctrine should not be applied in such a way as to assign the risk of loss to people who are unlikely to understand (or be able to learn about) the holder in due course doctrine and that the rule assigns to them the risk of loss. Investors in securitized loans are given detailed disclosure statements that should lay out the risks inherent in their investment. . 35 Creighton L. an individual borrower has little comparable access to information on the risk of fraud or whether an individual mortgage broker might be likely to commit fraud. such counseling is uneven and inadequate. [Fn595] The holder in due course renders such learning almost impossible because it is so arcane and conceptually difficult. they also have far more information regarding the magnitude of the risk of loss. which may be the most complicated financial transaction the borrower will ever experience. and ***Page622 faces further budget cuts. Lenders and investors in securitized loans not only have infinitely greater understanding of the holder in due course doctr ine than borrowers. stated. Securitization. [A] fundamental root problem leading to abusive lending is the confusion caused by the complexity of the mortgage process. especially the typical subprime borrower. Whenever a rule assigns risk to those who do not understand and are unlikely to learn about the rule. [Fn602] By comparison. the rule is acting inefficiently. lenders and investors in securitized loans are better able than borrowers to determine the assignment of risk caused by the holder in due course doctr ine. hardly a rabidly pro-consumer group. as such advice might cost thousands of dollars. is unlikely to be familiar with even the basics of the loan process. and the Holder in Due Course Doctrine. Servicers can build web pages that allow investors to obtain default rates and other loan performance information. Unethical lenders attempt to separate the borrowers from those who might provide valuable advice. These problems are exacerbated ten-fold in instances of uneducated or illiterate consumers. [Fn600] Subprime borrowers rarely have the help of an attorney in negotiating a loan secured by residential property. if the holder in due course doctrine were to assign risk efficiently to the party most likely to discover that assignment of risk and act on it. [Fn603] However. 503 (2002) Page 54 learn about the allocation of loss and the magnitude of the risk tha t they could bear. and consumers simply do not understand what they read nor what they sign. ***Page621 Any consumer that has ever been through a settlement knows how confusing and cumbersome the process can be. since lenders and the underwriters and ratings agencies who analyze risk for the investors are much better equipped to determine the risk of that fraud and to minimize that risk by refusing to deal with the unscrupulous mortgage brokers and loan originators likely to engage in fraudulent activities. on the other hand. Rev. looking for those even less likely than the average borrower to understand the effects of the loan. clearly it should assign such risk to the secondary market. extensive and detailed manuals regarding the law of lending. Lenders have attorneys.Held Up in Due Course: Predatory Lending. they are much less likely to do so in more complicated transactions that they rarely ***Page620 repeat. [Fn599] Unethical brokers target the elderly and undereducated. [Fn597] Clearly. [Fn598] The vice president of the Mortgage Bankers Association. The typical borrower. [Fn601] Therefore. [Fn604] Therefore. Mortgage disclosures are voluminous and often cryptic. and their own experience in the lending business. . since those people cannot be responsive to the rule and avoid or minimize the loss allocated by the rule. Loan counseling for bor rowers has been demonstrated to significantly affect the likelihood that a borrower will become delinquent on their loans. While people often learn about how loss is allocated in fairly simple. . The firms that rate loan securitizations have finely calibra ted methods to determine the risk of loss in the pools of loans and disclose tha t risk to the investors. assigning the risk of fraud to purchasers of mortgage-backed securities would do far more to deter fraud than assigning that risk to borrowers. [Fn605] . commonplace transactions.

Advanta. If the average borrower is the victim of mortgage fraud. despite the mortgage originator's contractual obligation to the servicer to provide the servicer one million dolla rs wor th of loans a month. the cost of taking legal steps to rescind the loan (especially if we add the emotional costs to homeowners of being the victims of fraud) is a sum sufficient to induce the borrower to take all ***Page623 effective precaution that she can. and the trustee. and the Holder in Due Course Doctrine. an investor in loans would take much greater precaution to avoid losing $100. claimed to be holders in due course in their answers to the complaint. such as TILA or its subsidiary HOEPA.000 could be so financially disruptive to the borrower. Rev.000 in the course of a loan transaction. [Fn612] After a year. unpredictable. [Fn610] Even where the holder in due cour se doctrine might apply. armed with a high-priced team of attorneys. [Fn611] the homeowner plaintiffs were promised by a mortgage originator that the interest rate on their loan would drop by almost 400 basis points (from 11. that risk might be assigned by other laws that take precedence over the holder in due course doctrine. For example. The risk of loss should be assigned wholly to the purchaser of the fraudulent loan. Four days after the loan closed. and its applicability to a loan is governed by facts likely to be in the hands only of the original lender. Both the servicer of the loan. as it is complicated. even without any risk of liability being assigned to her. 4. the securitization process is so complicated that cour ts often have great difficulty in determining who is the holder of a note and if that holder is a bona fide purchaser for value. [Fn607] Borrowers would exhaust almost their complete repertoire of precautionar y measures to avoid losing $3. Instead.Held Up in Due Course: Predatory Lending." [Fn606] This point is most likely reached quickly for the average borrowers. "there will be a point at which liability ceases to produce major increases in loss avoidance behavior. 35 Creighton L. along with the servicing rights. Securitization.000 than it would $3. [Fn609] Though lenders and investors in mortgage-backed securities are much more likely than residential borrowers to understand the holder in due course doctr ine's assignment of risk. especially for subprime borrowers who may have few valuable assets other than their homes. each loan meeting the terms of a sixteen . have in discovering how or whether the holder in due course has assigned the risk of loss. the note and deed of trust were assigned to defendant Bankers Trust. and might not be able to take many more steps to avoid losing $100. clear. and decisive. As we have seen in our discussion of HOEPA. The Uncertainty of Risk Assignment by the Holder In Due Course Doctrine For a rule assigning risk of loss to work efficiently. she will likely be forced to pay an attorney thousands of dollars to attempt to undo the loan. opaque. Bankers Trust. 503 (2002) Page 55 A party's responsiveness to liability does not necessarily continue to increase as the amount of liability increases. one sign of the growing unworkability of that doctrine is the increasing difficulty tha t even lenders and investors. when the interest rate was ***Page624 not lowered as promised..000. to encourage it to engage in the much more effective precaution available to it. because the law is complex. This differing loss responsiveness indicates that the holder in due course doctrine assigns risk of loss in the exact opposite direction than it should. First of all.9% to 8%) after one year. and often overruled by other laws.000. neither a purchaser of a loan nor the borrower may be able to determine. On the other hand. MG Investments. In other words. at least for consumers." [Fn608] The holder in due course doctrine fails miserably in this regard. increasing the amount of loss above that sum would not likely significantly increase their precaution. in England v. Inc. the plaintiff/homeowners attempted to cancel the loan and then sued to rescind it. absent judicial intervention. the rule should be "simple. Because the loss of the $3. whether HOEPA applies and eliminates the protection of the holder in due course doctrine.

" The court found that the servicer could not be a holder in due course because it was not the holder of the loan. [Fn619] and even though violations of HOEPA were evident on the loan's face. Bankers Trust and Advanta responded by filing a motion for summar y judgment. on the date of closing. Bankers Trust Company. the wrongs Hays asserts. and the trustee of ***Page625 the loan pool. Even though the loan seemed to be a HOEPA loan and so was not subject to the holder in due course doctrine pursuant to HOEPA. ." [Fn621] This case and the difficulty even a federal judge had in determining how to apply the holder in due course doctrine demonstrates that. who promised her a thirty year conventional loan. the sum it demanded." [Fn620] The court denied Advanta and Bankers Trust's motion for summary judgment. [Fn614] both Advanta and Bankers Trust claimed to be holders in due course. Spread the same loss out among 50. unnecessary losses as a result of the secondary economic dislocation . claiming violations of. 503 (2002) Page 56 page "Master Loan Purchase Agreement. The plaintiff was contacted by a different lender. that Bankers Trust had no knowledge of. and then declared bankruptcy. with loans subject to securitization. when one person bears the entire loss. . where Advanta was a "Master Servicer" and Bankers Trust the trustee for a pool of loans. at most. . but then. [Fn617] The court seemed mystified by the securitization of the loan and the relationship between the borrower. Bankers Trust apparently foreclosed on the plaintiff's house and attempted to evict her. could not be a holder in due course because it was never assigned the loan. Rev. but that the situation was too murky to determine whether the trustee was a holder in due course. the plaintiff allegedly attempted to bring her loan current by paying Advanta. both claiming that their status as holders in due cour se barred plaintiff's claims as to them. TILA and HOEPA. and the Holder in Due Course Doctrine. 35 Creighton L. that loss will be less onerous to them collectively.000 loss could devastate one person's life. Next. gave her paperwork for a fifteen year loan from a different company with a balloon payment and a different interest rate." [Fn613] Similarly. A $50. the court threw up its hands." [Fn618] The court concluded that Advanta. . the loan's servicer.000 fraudulent loan causes her to lose her house. the sum of which would hardly equal the pain of the one large loss. in Hays v. the trustee of the loan pools. the idea that if more people bear the risk of loss. the servicer. which placed the mortgage in a pool of loans and securitized it. After she fell behind on her mortgage payments. . The plaintiff sued. concluding that "[t]he record [wa]s simply too tangled for the Court to conclude. the loan was assigned twice. Loss Spreading. D. In economic terms. was a holder in due course. stating "the actual relations among MG/PMC. the court attempted to determine whether Bankers Trust. including the loan at issue in the case. TILA and HOEPA. Advanta and Bankers Trust remain obscure. single spaced "Pooling and Servicing Agreement" and stated "Advanta's status in this complicated credit transaction is less clear. or complicity in.Held Up in Due Course: Predatory Lending. None of this explains how Advanta ostensibly came to control the loan. Rather than accepting this sum. Loss Magnification. [Fn615] The plaintiff was a single mother of three who had taken out a loan from one predatory lender. The court examined the 134 page. at best. among other law. a homeowner's $50. causing a permanent and irremediable trauma if. [Fn616] On the date of closing. and the Holder in Due Course Rule Another factor determining the most efficient loss allocation is the loss spreading principle. each homeowner experiences a minor annoyance. first to yet another lender and then to defendant Bankers Trust. without more. and announced itself "unable to determine on the record now before it whether Advanta [wa]s a holder and whether Bankers Trust [wa]s an HDC [a holder in due course]. which refused to allow her to rescind. the holder in due course doctrine has become too complicated and its results too unpredictable for it effectively to notify anyone of its own assignment of risk. the servicer. for example. . the primary loss is much more likely to cause secondary. promised her that the lender would refinance her loan in a year at much lower interest rates.000 homeowners and. Securitization.

One is the theory that people are risk averse. Besides the possibility of economic dislocation. [Fn632] However. and so should bear that risk.Held Up in Due Course: Predatory Lending. this . two other theories have emerged to explain why loss spreading is desirable. the less each incremental increase of money is worth in real terms to that person. so long as the loss is not spread so widely that the loss spreading itself discourages the prevention of the loss. 503 (2002) Page 57 caused by the ***Page626 primary loss. investing money from pensions and other large funds in an array of investment devices. so that a $20. intensifying the risk through the foreclosure process. 35 Creighton L. There is no common insurance policy against predatory lending. either through an insurance policy or through self-insurance. imposing risk on the borrower magnifies it. investors in securitized mortgage pools have insurance built into their investment. and when the borrower has the risk imposed on her. [Fn623] Another theory is derived from the idea of the declining marginal utility of money. no individual pensioner would likely even notice the harm. the least expensive loss imposition system would be to leave the loss on whichever party initially suffered it. and so if faced with a small risk of a large loss. and the Holder in Due Course Doctrine. most people would pay more than $10 to avoid the risk entirely. [Fn622] The secondary loss of a house caused by the primary loss of the mortgage pr oceeds is one such example. Instea d of merely losing a fixed sum of money.000 loss. E. Instead of spreading the risk. so lar ge that the loss of a mortgage would barely even be noticeable to the investors.000 loss is a loss of money that is worth more to the victim. Loss Imposition Effective loss imposition looks to the costs of imposing the loss on whichever party is to bear it. As noted by Cooter and Rubin. economically minded commentators have largely agreed on its usefulness as a principle in allocating loss. By comparison. the participants in the secondary market are much better able to spread the risk of loss than borrowers. since the second $10. [Fn627] A primary method of spreading loss is through insurance. the borrower often loses her home. risk of loss should be assigned to the party that can most economically purchase or otherwise obtain insurance for that loss. and so spread the risk of it. only the licking of wounds by whichever party suffered the loss. each additional dollar of loss is worth more to that person than the dollar before. Rev. [Fn628] All other elements being equal. Securitization. [Fn626] ***Page627 Whatever the basis of the loss spreading principle. [Fn629] Homeowners have no effective method of engaging in loss spreading. there would be no resulting expensive litigation or negotiation after the loss occurred. often her sole means of security in her old age. The loan pools ar e enormous. which holds that the more money one has. investors are in effect joining together to self-insure en masse. [Fn630] By investing in a small part of such a large pool of loans. they would pay more than the amount at risk multiplied by the chance of it happening. she often pays by having her house foreclosed. we should weigh the wealth of the parties as a factor to consider and attempt to distribute risk more heavily to the wealthier party in a transaction. then in determining our distribution of risk. Clearly.000 loss causes more than twice as much pain as a $10. even if the pension fund somehow lost its entire investment in the mortgage pool. [Fn624] A corollary to this rule would be that as a person loses more money. even when it does not decrease the amount of loss. because a wealthier party forced to pay the same amount as a poorer party will value that amount less than the poorer party and so will lose less in the process. If faced with one chance in ten thousand of losing $100. even the investment in the mortgage pool ***Page628 itself is just part of a lar ger diversified investment. Because many of the investors are institutional investors.000. [Fn625] If we take the diminishing marginal utility of money seriously. Then. [Fn631] Risk has been carefully balanced by the poolers of the mortgage and should have been spr ead across the tranches in a carefully disclosed manner. therefore.

The holder in due course doctrine. the parties can obtain all of the benefits of a negotiable instrument merely by fulfilling the requirements of U. pending a successful borrower's suit. which is an off-the-shelf rule that governs a specific question if the parties do not specify their own rule. however efficient it may be in avoiding loss imposition costs. Richard A. "It is not obviously wiser for the consumer to decide to pay more for a product than to decide to give up one of his legal remedies against the seller. In our previous analysis.C. Reilly ar gues that the holder in due course doctrine efficiently allocates loss. [Fn634] Parties to an instr ument could explicitly specify whether it would have the characteristics of negotiability. since borrowers will be forced to litigate the issue of fraud in most cases. even without agreeing on specific language regarding the negotiability of an instrument or inserting language specifying the extent of negotiability. unless the parties contract around them. let alone understood by a consumer. [Fn636] However. The rule thus encour ages mortgage fraud. and so may be highly inefficient in terms of preventing or minimizing the impact of the loss. From this economic analysis. By comparison. Holder In Due Course as a Default Rule The holder in due course doctrine's specific role in the formation of contracts is that of a defa ult rule. [Fn635] Similarly. magnifies the harm caused by that fraud. Posner argues that. Academics who have applied a n economic analysis to the holder in due cour se doctrine have. [Fn633] In this case. ***Page630 Following in Posner's wake. thus saving the costs of negotiating the specific terms regarding the waiver of defenses. sometimes because one or more of the parties have failed to consider the possibility of the circumstances that have made the default rules necessary. Reilly argues that. the maker of the note is probably better able to obtain information regar ding the likelihood and magnitude of her own loss. the parties could obtain many of the benefits of a negotiable instrument by drafting language in the contract calling for the borrower to waive various defenses to the contract once the contract is assigned to a third party. and lenders will still likely attempt to foreclose on the loans if they are not paid. because it reduces the costs of collection while increasing its certainty. insure against that risk or bear that loss should it occur. Mar ie T. 503 (2002) Page 58 would often result in the loss being borne by a party that could neither take any precautions against the loss nor spread the loss in any way. lowers the cost to consumers of installment-financed purchases. § 3-104. F." [Fn639] This analysis implies that a consumer is the one who would make this decision. we assumed that all of the parties knew of the holder in due course doctrine and expressly consented to its operation on the negotiable instrument. and so is . default rules are designed to act whether or not the parties to a transaction are aware of them. and punishes the innocent borrower with that fraud once it occurs. unless the third party buyer of the instrument has knowledge of the maker's defenses or unless there are the so-called "real defenses" to the note. is extremely unlikely to be known. and the Holder in Due Course Doctrine. [Fn638] Posner concludes. Securitization. one of the purposes of default rules is to provide terms of a contract that parties have omitted. it is clear that the holder in due course doctrine misallocates the risk of loss due to fraud by allocating it to the party least able to prevent the fraud. making an instrument non-negotiable simply by writing "non-negotiable" ***Page629 across the face of it. decided that the doctrine is likely an efficient default rule or that its inefficiency cannot be demonstrated. by and large. 35 Creighton L. Rev. because it is not in the contract and is so obscur e and inherently difficult to understand. understand the allocation of risk. for example. [Fn637] Analysis of the holder in due course as a default rule differs from our analysis of its efficiency as a spreader of risk of loss in the following way.Held Up in Due Course: Predatory Lending. "unfavor able though it is to consumers.C." the holder in due cour se doctrine. In fact. imposing the risk of loss on the investors would not change net costs.

especia lly by consumers who ar e unlikely even to know of its existence. [Fn640] Similarly. Ian Ayres and Robert Gertner note that it is common for one party to a transaction to know of default rules while the other party remains in the dark if the first party is a repeat player. while the other party is a neophyte. She states: "Any rule that A. however. or (b) the efficiency of the doctrine is not affected by the fact that one of the parties does not understand the doctrine or its effect. an incentive to br ing up the subject covered by the default rules in negotiations a nd so inform the other party (here the borr ower) of the existence of the default rule. stating that the notion of the holder in due course doctrine as a default rule "eliminates the need for speculating about the exact reasons parties may have for wanting to waive claims and defenses. Somewhat less efficient would be a rule assigning the risk of loss to a knowledgeable repeat player rather tha n a naive novice. respectively. here the lender. the holder in due course doctrine may reduce the cost of accomplishing that result. and buyer. Gregory E. whether the holder in due course doctrine is. even if the overall benefit to both parties would increase if they were both informed and negotiated regarding the subject of the default rule. in a manner which benefits only the knowledgeable party. and bases his argument for the efficiency of the holder in due course doctrine on this conscious choice of waiving defenses. in the most extensive analysis of the holder in due course doctr ine as a default rule. Rev. ." [Fn644] She fails to discuss. [Fn646] The better informed party in this situation may intentionally remain silent about the default rule to maximize its own profits. 503 (2002) Page 59 the better insurer. [Fn649] ***Page632 Applying these arguments regarding default rules to the holder in due course doctrine shows that this rule tends to work most efficiently only among par ties who understa nd the rule and can determine the value added to or subtracted from their wealth by the operation of the rule. a premise unfounded in the use of negotiable instruments in consumer contracts or loans. Whatever their reasons. let alone whether. 35 Creighton L. B. if competent parties choose to waive claims and defenses. and the Holder in Due Course Doctrine.Held Up in Due Course: Predatory Lending. and C [the maker. Similarly. easily applied. [Fn647] The knowledgeable party is most likely to remain silent where the default rule favors it rather than the uninformed party. especially where transaction costs a re small and so parties are relatively free to negotiate regarding the terms of a contract. Maggs assumes that people who use negotiable instruments want to waive their defenses to those instruments. [Fn645] Crucial to the efficiency of the holder in due course doctrine as a default rule is whether both parties to the original transaction know of and understand the doctrine and how it assigns risks. Marie Reilly views the holder in due course doctrine as efficient because it provides an easy. the doctrine will apply to their loan. [Fn648] Ayres and Gertner conclude that. rather than leaving it. This premise is that either (a) both par ties to the instrument understand that it is negotiable and understand the effects of the holder in due course doctrine. [Fn641] The work of each of these commentators is based on a fundamental unstated premise." [Fn643] What this analysis ignores is whether the makers of negotiable instruments either intended to waive any claims or defenses or understood the holder in due course doctrine and what its effects might be. Maggs. original beneficiary. Their particular pur poses do not matter. This would give the more knowledgeable party. of the potentially negotiable obligation] can easily apply to determine the likelihood that an obligation will fall into the hands of ***Page631 an immune party enhances efficiency by reducing costs. concludes that the doctrine exists primarily to reduce the transaction costs of negotiating waiver of defense clauses that would spring up were the doctrine eliminated. Securitization. given HOEPA's restrictions on the holder in due course doctrine. certain method of determining whether the maker of an instrument has waived defenses if the instrument is purchased by an innocent third party. perhaps inefficiently. " [Fn642] Maggs goes on to note: "[M]ost parties who want to waive defenses choose negotiable instruments. repeatedly participating in similar transactions. default terms should be set to favor the party most likely to be unaware of them. leading the parties to contract explicitly regarding the subject and so resolving it efficiently through negotiation. in fact.

This default rule. If the initial assignment is not to the most efficient user. and the Holder in Due Course Doctrine. From this analysis. realizes that she will be assigned various risks as a result of the rule. he does not knowingly exact a better pr ice in return. or (2) when the risk assigned to the maker of the negotiable instrument through the holder in due course doctrine is so negligible that it is unlikely to tip the balance of costs and benefits to the maker of the instrument. therefore. the buyer is likely to be paid back for giving up his defenses with excessive prices. we can reach the conclusion that the holder in due course doctrine is likely to be efficient only under one of two sets of conditions: (1) when the maker of the negotiable instrument understands the rule. and in a dishonest market. In commercial contracts. [Fn652] And because the buyer unintentionally gives up his defenses. but would instead receive a price increase. in an honest market. where the buyer would have few defenses. he is not even alerted that he must take extra precaution to defend himself against the shady dealer. and can appraise the magnitude of those risks. "statistically unnecessary. reflecting the value of the defenses. parties may omit a rule because . default r ules play a far different role than they do in commercial contra cts. Only then can she make the kind of informed choice about whether to enter into the transaction that is required for efficient transactions." [Fn651] Where the buyer most needs the protection of her defenses. [Fn654] This has been termed the "sticky default. Default Rules as Gap-fillers in Standardized Consumer Contracts: The Uniform Code's Defense Against Claims of Unconscionability In the context of standardized consumer contracts.Held Up in Due Course: Predatory Lending. they would have to pay for that transfer. they want to avoid the transa ction costs of negotiating a specific rule. in Homer Kripke's words. Securitization. He would unwittingly pay a lower cost in return only where the market is so efficient that it forces the lenders to reduce the interest rates and fees they charge when their collection costs decline. since people tend to ask more in price to give up something than they would be willing to pay to acquire that same thing. Rev. default rules are used most often when the parties have not included a rule governing a specific situation. either intentionally or unintentionally. Given the near impossibility of residential borrowers understanding the holder in due course doctrine and the great risk of predatory lending in the subprime market. 503 (2002) Page 60 [Fn650] If someone is making a note. In other words. the price reduction that the buyer would receive would be minimal. and even if they could effectively negotiate to transfer the risk of loss. G. or they consider the possibility of the situation occurring too unlikely to concern them. one of the ter ms that should be the subject of negotia tion is whether or not the note will be negotiable. in instances of fraud or other forms of sharp dealings. neither condition is satisfied for subprime loans. the seller is already attempting to extract from the buyer a price that ***Page633 is above the market price for the good delivered. [Fn656] Unintentionally. Parties intentionally omit a rule for a multitude of reasons: they have been unable to agree on a specific ***Page634 rule." [Fn655] Even if borrowers were to realize that the holder in due course doctrine assigned the risk of loss to them rather than to assignees of the loan. provides a permanent subsidy to lenders at the expense of borrowers. the non. the buyer is likely to receive very little return for giving up his defenses. that user will exact a price. Even if all of the parties are equally familiar with the default rule. or both. the rule's assignment of risk or benefit affects the ultimate distribution of gain or loss from a contract. In an honest market.efficient user is likely to increase his asking price simply because the benefit was initially assigned to him. 35 Creighton L. If the consumer unintentionally gives up his remedies against the seller. shoddy merchandise. the buyer is highly unlikely to obtain any price reduction for having given up some of his defenses. which is so small as to be. either by charging an excessive price or by supplying inferior products or no products at all. In such a situation. [Fn653] In fact.

because one party ha s had free rein to predetermine ***Page635 all of the rules contained in the standardized. since the standardization of consumer contracts already avoids those costs. Secondly. [Fn660] Nor are they omitted to avoid transaction costs. the sellers and lenders accomplish several tasks. to supply the terms that the parties would have agreed to had they been able costlessly to bargain specific terms. typically contra cts of adhesion. 503 (2002) Page 61 they did not conceive of the situation or expect that it could occur. a customer is much less likely to make its purchase or bor rowing decisions based on the contract. understand. since the same likelihood of such an event that would generate a default rule. many commentators agree. is to protect the enforceability of terms that could be held unconscionable were they contained in the text of standardized. 35 Creighton L. In this way. in the unlikely event that she reads all of the pur chase or loan documents. [Fn659] The default rules do not come into play because the parties have been unable to agree on a rule. they avoid the possibility that the consumer or borrower. but if the Uniform Commercial Code. would also notify the commercial party of the need to include such a term in its contract. The seller or lender avoids the necessity of either explaining or defending the harsh term and the possible liability that may result from misrepresenting the effect of the ***Page636 harsh term. First of all. in order to fill out the contract. and the Holder in Due Course Doctrine. If the harsh terms are nowhere to be found in the contract. adhesive consumer contracts. Rev. The consumer typically does not even read the form contract. will note. let alone bargain over its terms. since that term will appear nowhere in the agreement. of any lack of awareness by the drafters of the contracts of the possibility of an event. Default terms are used. such as risk of fraud or deception. Indeed. with which any professional drafter of standard loan documents should be intimately familiar. such as the holder in due course doctrine. the primary purpose of a default rule in standardized contracts that harms a consumer. [Fn657] This use of ga p filling matches the idea that economic efficiency is most likely to result from the voluntary informed agreement between the parties. Securitization. By omitting those terms from individual contracts and incorporating them generally through gap-filling laws.Held Up in Due Course: Predatory Lending. Similarly. and challenge the harsh term. [Fn658] By comparison. form contract. the risk of fraud for example. The default rules allow such terms to be imported into those contracts in a way tha t makes it impossible for a court to declare them unconscionable. in standardized consumer contracts. the court will be hard pressed to find the waiver unenforceable. typically. the sellers and lenders minimize the chance that other lenders will lure away their customers by supplying better terms. the holder in due course doctrine encourages the formation of unconscionable contracts by providing a legal cloak to cover that unconscionability. the use of default rules in consumer contracts that benefit sellers or lenders at the expense of borrowers and consumers allows the seller or lender to benefit from harsh terms in the sales or loan contracts without having to incorporate those terms into the contract or loan agreement itself. the holder in due course doctrine governs possibilities. waives that same defense. as enacted by a state. [Fn661] Nor are the omissions the result. default rules serve a very different purpose. [Fn662] . A court might well declare a contract term waiving any defenses a non-commercial borrower might have unconscionable. Instead.

which governs negotiable instruments. and the Holder in Due Course Doctrine.C. long after many legislative and judicial battles over what protection should be given to non-commercial borrowers. . The revisers of Article 3 intentionally refused to alter Article 3's distribution of risk between non-commercial borrower and lender. The OTC and the Federal Reserve Board have only limited powers to regulate all of the mortgage brokers and non-federally insured or regulated lenders across the country.C. The likelihood of such a change seems small. since commercial actors quickly incorporate waiver of defense clauses to replace the holder in due course doctrine when it suits their purpose. [Fn665] Even the drafters' efforts to abide by this charge were deemed too far-reaching. Other federal actors could claim to be hamstrung. . to reverse the holder in due course doctrine in every instance where it is applied to any non-commercial loan. If the GSEs.C. changed their form promissory notes to include an FTC-like disclaimer preventing the cut-off of defenses. [Fn666] While more consumer protection has crept into the revision of Article 9. Therefore.C. One possible method of reversing the holder in due course doctrine would be through revising U.C.Held Up in Due Course: Predatory Lending. even if not. Such state-by-state action would create a patchwork system and vastly reduce the uniformity of the laws of negotiable instruments. the benefit in fraud reduction would likely outweigh the costs of uniformity. given the history of drafting and revision of the U. it seems unlikely that the guardians of the U.C. bona fide or otherwise. 503 (2002) Page 62 VII. such as Fannie Mae and Fr eddie Mac. However.C. and instead. it seems hopeless to think that this is an issue a residential borrower can bargain over meaningfully. However. consistent with the traditional U.C. mere elimination of the holder in due course doctrine is not sufficient. States could individually alter their laws so as to eliminate the holder in due course doctrine from non-commercia l loans and preserve ***Page638 borrower defenses. in the place of the holder in due course doctrine should be a non-waivable rule preserving any defenses that such a borrower would have as to any assignees. . as noted in Section II(E). [Fn667] Another possible actor that does much to reverse the holder in due course doctrine in non-commercial loans would be the GSEs that acquire so many of the prime residential loans. of affirmative consumer protection provisions from revised Articles 3 and 4. [Fn663] The incorporation of such clauses in pre-printed contracts of adhesion would be as little bargained over as the current rule. In effect. 35 Creighton L. the GSEs would soon force all of the prime market and that limited portion of the subprime market that the GSEs purchase to include such a preservation of borrower defenses. this lack of uniformity could convince the U. though there would be no legal obligation to do so. POTENTIAL METHODS OF ELIMINATING THE HOLDER IN DUE COURSE DOCTRINE FOR NON-COMMERCIAL LOANS The holder in due course should be abolished in any instance where it would assign the risk of loss for a loan to a non-commercial borrower. Article 3 was last revised in 1990. The remainder of the subprime market that is securitized could conceivably follow suit. the holder in due course should be reversed and the risk of loss due to the originator's fraud or deceptive practices should automatically be assigned to the purchasers of loans. . approach. Securitization.C. drafters to change the rule uniformly to protect borrowers and. if one can speak of a "balance" in such a pro-banker code.C. Fred Miller notes the "exclusion.'s Article 3. though they could order regulated banks to purchase only loans containing an express preservation of borr ower defenses. the revision was limited to minor rewordings with little r eal change. will be ready any time soon for such a bold and necessary stroke as reversing the holder in due course doctrine in all non-commercial loans." [Fn664] The drafters of the revised Article 3 were under fairly explicit orders not to ***Page637 alter what some have referred to as the "balance" Article 3 establishes between consumers and bankers. Rev. Given the complexity of the holder in due course rule.

the interest rate charged subprime borrowers should. then the purchasers of subprime loans will be much less likely to deal with an unscrupulous lender and will go to much greater lengths to avoid those lenders whose aggressive marketing tactics verge on predatory lending. it would almost certainly lower it. Instead. VIII. subprime borrowers are not sufficiently effective price shoppers. the subprime market is not an efficient one. 503 (2002) Page 63 The agent best able to eliminate the holder in due cour se doctrine for r esidential loans a nd replace it with a preservation of borrower defenses would be Congress. fewer borrowers will obtain loans because of the marketing blitz that predatory lenders use. and the more legitimate subprime lenders find a clear er pa th to the borrowers. then that lender can declare ba nkruptcy. THE EFFECT OF ELIMINATING THE HOLDER IN DUE COU RSE DOCTRINE The traditional view is that the holder in due course doctrine allows lender s to charge somewhat lower interest rates. the effect on interest rates would likely be so negligible as to be unnoticeable. leaving the borrowers with little recourse for the fraud committed on them. As demonstrated by the fact that so many subprime borrowers could have received prime rate mortgages at a significantly lower cost and by how much more the subprime market charges A. just as it did in a more limited fashion through HOEPA. and the Holder in Due Course Doctrine. 35 Creighton L. but by relying on more aggressive or misleading sales techniques than their competitors. If the holder in due course doctrine is eliminated. The extent of the likely decline can be estimated based .borrowers than the prime market does. higher cost loans. Securitization. decline significantly. because of the holder in due course doctrine. is the understanding that. [Fn670] Subprime lenders ha ve too often competed with each other not by offering lower ***Page639 rates. So long as the lender follows TILA and skirts the triggers for HOEPA. for the prime market. There is so little fra ud in the prime market in pr oportion to the size of the prime market tha t the transference of risk of fraud fr om one party to another will have almost no effect on the price of credit. since they bear less risk of loss and would. and often purchase more expensive credit when less expensive credit is available to them. [Fn671] Many borrowers have been induced to purchase credit at above market rates through the aggressive marketing and dubious and deceptive sales techniques that have been the hallmark of predatory lenders and all too often practiced even by more mainstream subprime lenders. rather tha n increa sing the cost of subprime credit. Whether it will have the political coura ge to do so remains to be seen. One of the reasons that subprime lenders have been free to engage in this aggressive marketing and that the financial markets have been willing to securitize the resulting loans. or the nature and effect of credit products packed into the loan. Fewer will be tricked into entering into loans based on oral misrepresentations regarding future loan reductions. the argument goes. If enough borrowers sue the initial lender. spend less money to defend suits by disgruntled borrowers. [Fn668] Eliminating the holder in due course doctrine in the subprime market could well affect the price of credit to subprime borrowers. Competition among predatory subprime lenders has been to see which company could reach the elderly. then the holder in due course doctrine reduces the possibility that the purchaser of the loans will lose any money based on those predatory practices.Held Up in Due Course: Predatory Lending. not by offering better services. the undereducated. [Fn669] In other words. but by flipping more borrowers into new. Rev. or naive or easily confused first and obtain a high cost loa n well above the market rate given the risk characteristics of the borrower. which has the power to eliminate the holder in due course doctr ine generally on non-commercial loans. the buyers of these loans are virtually immune from the borrowers' suits alleging many of these forms of fra ud. As a result. on average. As the predatory lenders are starved by the financial markets.

Owns 126 Neglected Houses in Buffalo. See generally the findings of fact in Newton v. An y errors are. The holder in due cour se doctrine is no longer necessary in non-commercia l loans. [Fn4]. Dec. Fin. [Fn3]. March 5. at C5. 503 (2002) Page 64 on the amount that the subprime market currently appears to be overcharging its borrowers.D. 2001. Rev. 1984. CONCLUSION The time has come to end the holder in due course doctrine in the last area where it is damaging the innocent. Nat'l Mortgage News. Its purpose of providing liquidity to those loans has been taken over by securitization. Thus. president of the Western New York Association of Mortgage Brokers. min e. 2000. Most of all. Assistan t Professor of Law. 2000 WL 5703112. Mox v. U. 24 F. . [Fn2]. fin ding th at she had not received the proper loan disclosures. Kath leen Keest. 17. [Fn1]. let alone its effect.2d 114. News & World Rep. Da niel Bogart and Will iam Stall worth for useful suggestion s. Jordan. inter est rates to subprime borrowers would likely decline ***Page640 by an amount commensurate with the 100 basis point excess that subprime lenders currently cha rge subprime Aborrowers over prime A. 1996. based on various studies.Held Up in Due Course: Predatory Lending. 115 (Mich. 2001 WL 6319836 (quoting seventy-two year old Goldie Johnson. Supp. [Fn672] IX. non-commercial makers of negotiable instruments who have no way of knowing of its existence. We must finally end the pernicious effects of widespread. who suffers from glau coma and was i nduced to sign a loan with monthl y payments of about eighty percent of her fixed income and a balloon payment that comes due the same year she turns eighty-six). La. United Cos. 1996 WL 11670028. Newton. Nan cy Schultz for helpful editing. Fortunately for Ms. with no clear idea of negotiability or its effects. 2d 444 (1998) and Unit ed Companies Financial Corp. Univer sity of Californ ia-Berkeley (Boalt Hal l). Buff. Ronald J. and the Holder in Due Course Doctrine. Michnik. I would like to than k Clare Pastore for her p atien ce and help. reported in High Risk Loan Disaster a Bankrupt Mortgage Lender from Baton Rouge. which has provided more ease in the transfer of notes than the holder in due course doctrine ever could have done. Sometimes a Deal Is Too Good to Be True Big-bank Lending an d Inner-cit y Evictions. J. Jeff Glasser.. both in h er extensive comments on this ar ticle and otherwise. It is time to return the proper role of intent to that law by preventing those who are unlikely to understand the holder in due course doctrine or to intend they be bound by it from creating negotiable instruments.. I would like to thank Elizabeth Renuar t. she found legal help. an d Car oline Hahn for cheerful research.. Which Gave High-Risk Loans to People with Dama ged Credit Rating s. unintentional negotiability. sued United Companies.borrowers.000. of course. 1990). News. Ben Diehl. [Fna1]. 463 N. 35 Creighton L. at 40. I would also like to thank the staff of the Western Center on Law & Poverty for providing me office space. The history of the negotiable instrument at first was the story of the intent of the makers of negotiable instr uments driving the legal development of those instruments. It is no longer needed to provide an effective currency substitute. however.. referring to the mortgage originating ar m of United Companies Financial Corp. The banking and lending industry has too long reaped the benefit of seizing control over the codification of negotiable instruments law. Corp. Securitization.S.W. App. Grows B&C. Since the codification of negotiable instruments law. the history of negotiable instruments has been that of the victimization of makers of negotiable instruments who neither intended nor understood they were making negotiable instruments. and its takeover by bankers and their attorneys. June 6. Chapman Univer sity Sch ool of Law. and in November 1998 the court rescinded her loan and awar ded her $2.

v. unless and until they can agree on a definition of predatory lending.responsiblelending. Bunce. 35 Creighton L. Remarks at the Federal Reserve Bank of Phil adelphi a. [Fn8].. Predatory Lending Practices in the Home-Equity Lending Market: Prepared Statement Before the Board of Governors of the Federal Reserve System. Indeed. See generally Kurt Eggert. L. it does not lend itself to a concise or a comprehensive definition. 2001). 2000).pdf (last visited Mar. 117.J. Gramlich. [Fn12]. 25. it would seem impossible to find common agreement on exactly how widespread predatory lending is among those who cannot even agree on the definition of predatory lending. Qu antifying the Economi c Cost of Pr edator y Lendin g. Ehrenberg. Allen Fishbein & Harold L. 2002).gov/<tilde> banking/docs/repor ts/pr edlend/pr edlend. 363 (2002). r egulators sh ould not take further regulatory action to stop such practices. In its report on predatory lending. 503 (2002) [Fn5]. 119-20 (2001). [Fn16]. Rev. 2001). at http:// www. Held Up in Due Course: Codification and the Victory of Form Over Intent in Negotiable Instrument Law. Apr. though conservative.--U. 6. Home Equity Servs.' much like the terms 'safety and soundness' or 'unfair and deceptive practices. at http:// . 2001.org (revised Oct. Dep't of Housing and Urban Dev. 9.. This report is also available at 54 Consumer Fin. Id. Page 65 [Fn6]. Troup.org (revised Oct. See also Federal Trade Commission.hud. A Report from the Coali tion for Responsible Lending 2. 2000) (reporting to Chairman Gram m).S. Slowing Economy Blamed For Rise In Mortgage Fraud. 2001). Commun ity and Consumer Affair s Departm ent Conferen ce on Predatory Lending (Dec.responsiblelending. 2002). 2002). L. 106th Cong. at http:// www. 1. the staff of Senator Phil Gramm argued that. 20. 2000) at http:// www. Eric Stein. "The term 'predatory lending. Rev. A Report from the Coali tion for Responsible Lending 2. Predatory Lending Practices: Staff Analysis of Regulators' Responses. On Banking.gov/os/2000/09/predatorylending. at http:// www. [Fn17]. stating "Providin g a clear defin ition is t he beginn ing step a nd cann ot be skipped. 2001). Securitization. Qu antifying the Economi c Cost of Pr edator y Lendin g. Daniel S.' is far-reaching an d covers a potentially broad range of behavior." Id. at http:// www.ftc. 20. Eric Stein. 228.sen ate. a vaila ble at h ttp://www. Don't Take It: Applying the Suitability Doctrine to the Mortgage Industry to Eliminate Predatory Lending." Staff of Senate Comm. Th at step ha s not yet been taken by the regulators. 2002). [Fn10]. Housing and Urban Affairs. (Sept.responsiblelending." Edward M. [Fn18]. Dep't of the Treasury Task Force on Predatory Lending. As such. Eric Stein. [Fn15]. 26. Gramlich noted. [Fn11]. See Assocs. It would be impossible to measure the exact amount of predatory lending without first selecting a specific definition to determine which loans are predator y. at 13. Todd Silberman. 23.Held Up in Due Course: Predatory Lending. Id. at 12-13. Dev. Subprime Market Growth and Predatory Lending. Joint U. The report calls its estimates "rough. at 2-3. Federal Reserve Board Governor Edward M. [Fn9].2d 529 (N. Qu antifying the Economi c Cost of Pr edator y Lendin g. and the Holder in Due Course Doctrine. 778 A. & Cmty. News & Observer (Raleigh NC). If the Loan Don't Fit.htm (last visited Mar. 20.htm (last visited Feb. 10 J.federalreserve. Super.htm (last visited Feb.gov/library/bookshelf18/pressrel/treasrpt. [Fn14].Q. Curbing Predatory Home Mortgage Lending 1 (June 2000). 2001 WL 3458996 (quoting James Croft. A Report from the Coali tion for Responsible Lending 2. 35 Creighton L. which researches mortgage fraud). Rep. [Fn7].S.gov/boarddocs/speeches/2000/20001206. Affordable Hous. 7. at http:// www. 228-32 (Summer 2000). [Fn13]. h ead of the Mortgage Asset Research Institu te. at B8.org (revised Oct. (August 23.

Stat e of Iowa. and Urban Affairs. Impact and Responses: Hearing Before the Senate Comm. 26. A Report from the Coali tion for Responsible Lending 9-10. News.45 (1998).pdf (last visited Mar. at http:// www. at 16N. 2000. Member. at 7. Joint U. 2000)). L. and the Holder in Due Course Doctrine. Securitization. [Fn22]. Rev. Rep.org (last visited Feb. 2000. Chairman. Chi. A Report from the Coalition for Responsible Lending 2. Cathy Lesser Mansfield. at http:// www. at 4. Keest. at 4. At torney General. On Bankin g.html (last visited Mar. 2000).sen ate. Mortgaging Serv. at http:// www. A Report from the Coalition for Responsible Lending 2.gov/library/bookshelf18/pressrel/treasrpt. Housing. Letter from John D. 2002). Donna Tanoue. 20. 1 (Ma y 5. Curbing Predatory Home Mortgage Lending 76 (June 2000).--U. [Fn25]. 2000. Quantifying the Economic Cost of Predatory Lending. 503 (2002) www. 242 n. [Fn21]. See Edward M. Hawke. Stone Soup: Exploring the Boundaries Between Subprime Lending and Predatory Lending. Dep't of the Treasury Task Force on Predatory Lending. A recent Freddie Mac study concluded that 100 basis points of subprime loan pricing was not explicable by the borrower's credit risk. Sun-Times. See Comments of the National Consumer Law Center and Consumer Federation of America to the FDIC on Predatory Mortgages.S.Q.htm (last visited Feb.S. at http:/ /www. 52 Consumer Fin. 2000 WL 18803344. Senate Committee on Bankin g. 27. Subprime Lending Developments With Implications for Creditors and Consumers. of the National Consumer Law Center. Kathleen E. Berger. Alvin C. Dec.responsiblelending. 547 n. The Road to Subprime "HEL" Was Paved With Good Congressional In tentions: Usury Deregulation and the Subprime Home Equity Market.gov/<t ilde> banking/docs/reports/predlend/occ. assistant secretary for h ousing at HUD. Subprime Lending Produces Dangerous Side-Effects. Remarks at the Fair Housing Council of New York (April 14. (2001) (testimony of the Honorable T homas J. Jr. 10. [Fn28].senate. 1133 (2001). James T. Predatory Mortgage Lending: The Problem. July 26. [Fn30].or g (revised Oct. Rev. Qu antifying the Economi c Cost of Pr edator y Lendin g. from Day One people can't repay them. News. 10. 35 Creighton L. [Fn23]. June 16.htm (l ast visited Mar. 2001).C. 21. 107th Cong. since a borrower. as sayin g "In many of these [subprime] loans. 473. [Fn31]. This analysis was suggested to me by Elizabeth Renuart.gov/01_ 07hrg /072601/mill er. available at http:// banking.org/publications/pdf/brd/13Fishbein. 'Predatory Lending' Raises Default Risk. Dep't of Housing and Urban Dev. 2000 WL 6681282 (quoti ng Willia m Apga r. 25. 2002). 9. 1241 PLI/Corp 1107. Mortgaging Serv. 20. Donna Tanoue. 'Predatory Lending' Raises Default Risk. 2000). [Fn24]. We are just setting people up for failure. 2002). Mi ller. and Urban Affairs. L. 2002). See Eric Stein.453 (2000). June 9. even if she does not lose her home to foreclosure. has a significant amount of the home's equity stripped from her when she pays excessive fees or prepayment penalties. to Phil Gramm. Eric Stein. Id.responsiblelen ding. Comptroller of the Currency.huduser..org/predatory_lending/fdic. available at 2000 WL 378316.org (revised Oct. Housing. 2000 WL 18803344. 2001). at http://www. 2002). Subprime Lending: An Investigation of Economic Efficiency (Freddie Mac. 51 S.responsiblelending. Board of Governors of the Federal Reserve System. 238. Gramlich. 546-47. [Fn20]."). June 16. Page 66 [Fn19]. [Fn29]. [Fn26].pdf (last visited Mar.hud. Eric Stein. "Equity str ipping" i s also used mor e broadly to refer to paymen t of excessive fees of all types.Held Up in Due Course: Predatory Lending. . Harrell. [Fn27]. 2002). 2001) (citing Pet er Zorn.nclc. at http:/ /www. Quantifying the Economic Cost of Predatory Lending.

Securitization. June 27. available at http://www.org/acorn10/predatorylending/plreports/report.S. at http:// www. [Fn43]. (Aug. available at 1998 WL 8993304. 2001.gov/os/2001/02/predlendstate. 27. available at 2001 WL 9238572. if the loan agreement was silent as to prepayment. Kathleen E. Stalking the Predators/State Legislature Eyes More Restrictions on Lending. 72 Cornell L. [Fn38]. 473. 20. 51 S. Rau. 2001). 23. making all borrowers eligible to prepay their loans without penalty absent a contrary provision in their loans. Before 1938. (Feb. The Road to Subprime "HEL" Was Paved With Good Congressional In tentions: Usury Deregulation and the Subprime Home Equity Market. 2001. [Fn45]. For a scholarly argument that prepayment penalties lower the interest rates charged borrowers. Whitman. June 27. 2002). [Fn44].org (revised Oct. 2002).Held Up in Due Course: Predatory Lending. Stalking the Predators/State Legislature Eyes More Restrictions on Lending. (Feb. at A06. 1241 PLI/Corp 1107. Letter from Dan Immergluck.ftc. June 27.gov/os/2001/02/predlendstate. and the Holder in Due Course Doctrine. [Fn40]. .C. 2001). 288. Rev. 40 UCLA L. 2001).org/hoepa. [Fn39]. Jordan Rau. L. Keest. Newsday. Davies.acorn. 35 Creighton L. 1129 (2001). the borrower had no right to prepay a loan and could only pay it out over the entire term of the loan. ACORN (Ass'n of Cmty. See also Dale A. 851. see Frank S. lenders began inserting prepayment provisions in loan agreements.521 (2000). 7. Rev. at http:// www. Eric Stein. 2001 WL 9238572. Id. 503 (2002) Page 67 [Fn32]. [Fn33]. 1998). [Fn37].htm (last visited Feb. Alexander. at 289. 2001. Prepared Statemen t of the Federa l Trade Com missi on before the Califor nia State Assembl y Commit tee on Banking and Finan ce on Predatory Lending Practices in the Home-Equity Lending Market. [Fn41]. 20 00). 16. Senior Vice President. 72 Cornell L.htm (last visited Feb. [Fn42]. Newsday. avail able at http://www. for Reform Now). Mar. [Fn36]. 2002). (1998) (statement of Jim Dough. 558 n. at 289. After the Home Loan Bank Board reversed this default rule.html (last visited Feb. Mortgage Prepayment Clauses: An Economic and Legal Analysis. Alexander. [Fn46]. [Fn34]. Predatory Lending Practices: Hearing Before the U.ftc. Woodstock Institute. Separate and Unequal: Predatory Lending in America 30 (Nov. 2001 WL 12167836. A Report from the Coali tion for Responsible Lending 5. at A06. 14.woodstockinst .responsiblelending. Mortgage Prepayment: The Trial of Common Sense. Phil. available at http://www. Id. 330-31 (1987). Rev. [Fn35]. to the Board of Governors of the Federal Reser ve System. Rev. Newsday. 21. Rev. 2002). 2001 at A06. 16. Feb. Subprime Lenders Prey on Hard-Luck Consumers. Daily News. Qu antifying the Economi c Cost of Pr edator y Lendin g. on Aging. 860 (1993) for a discussion of the windfall a lender can receive from p repayment p enalties. Jordan Rau. 23. Stone Soup: Exploring the Boundaries Between Subprime Lending and Predatory Lending. 2001 WL 9238572. Senate Special Comm. Paul D. Prepared Statemen t of the Federa l Trade Com missi on before the Califor nia State Assembl y Commit tee on Banking and Finan ce on Predatory Lending Practices in the Home-Equity Lending Market.htm (last visited Feb. 2001) (citations omitted). Orgs. 326. especially where a borrower prepays the loan when market interest ra tes have increased. 23. 105th Cong. 21. Cathy Lesser Mansfield.

Id. 63 Va. available at 2000 WL 378316. One Hundr ed Years of Ineptitude: Th e Need for Mortgage Rules Consonan t with the Economi c and Psychological Dynami cs of the Home Sale and Loan Transaction. at http:/ / www. Don't Cure Predatory Lending By Killing Subprime. L. See also Preval ence of Pr epaymen t Pena lties. Preda tory Lending Tar geted States Are Trying to Stem the Increasin g Number of Vulnerable Homeowners Victimized by Near. (Mar. Mortgaging Serv. The holder in d ue course doctrin e preserves this distin ction between fair . See discussion of the real defenses infra note 102 and the accompanying text. [Fn49]. see Edward M.. 2001. June 16. Jr. A. a sizeable increase from 1997. Protecting Consumers from Overdisclosure and Gobbledygook: An Empirical Look at the Simplification of Consumer-Credit Contracts. 26 UCLA L.A. 27. 2000 WL 18803344. See discussion of holder in due course doctrine in section II(E). 35 Creighton L. (2000) (testimony of Ralph Rohner. at A1. For a discussion of the effectiveness of TILA disclosures. 2001 WL 11595211. 2000 WL 19304101. Remarks at the Fair Housing Council of New York (Apr. 19. News. when fifty percent had such pena lties. 2000). Id.h tm (last visited Feb.responsiblelending. Board of Governors of the Federal Reserve System. Rohner. Member.responsiblelen ding. Rev. 20.. 2000 WL 4389922. Eric Stein. 1133 (1984) (citing Jeffrey Davis. see William N. 843-44 (1977) and Jonathan M. 2000 WL 378316. 2000). 9. 721-34 (1979)). [Fn60]. 2000. infra. See Victor Epstein. [Fn53]. 30. 25.. Jan . House Rich Elderly Easy Ta rgets for Mor tgage Scams. 106th Cong. [Fn48]. at http:// www. and the Holder in Due Course Doctrine. See Donna Tanoue. James R. 14. Kathleen E. Gramlich. Member. Eskridge. 23-24. 1083. [Fn50]. Nov. [Fn52]. . See citation to study in Home Bound: Nasty Surprise Haunts Some Folks' Mortgage: A Prepayment Penalty. Special Counsel to the Consumer Bankers Ass'n. at 4. Peterson. 'Predatory Lending' Raises Default Risk. 2000. 20 01 WL-WSJ 2871 388. [Fn51].responsiblelending. Eric Stein. L. at 14. 70 Va.or g/CoaltionStudies/Prevalence%2 0of%CC20Prepayment% 20Pen alties. Qu antifying the Economi c Cost of Pr edator y Lendin g. A Standard and Poor's survey found that approximately eighty percent of subprime mortgages contained a prepayment penalty in mid-2000 . Keest. 2001). at 1M.Held Up in Due Course: Predatory Lending. Nat'l Bar Ass'n Mag. Coalition for Responsible Lending. 841. 503 (2002) Page 68 [Fn47]. J. 2000). Mortgage Lending Abuses: Hearing Before the House Comm. Landers & Ralph J. 2001).-Feb. Securitization. Omaha World-Herald. A Functional Analysis of Truth in Lending.org (revised Oct.org (revised Oct. May 1. A Report from the Coali tion for Responsible Lending 9. 711. Rev. Qu antifying the Economi c Cost of Pr edator y Lendin g.. 2001) (citing the director of Mortgage Information Corporation as reporting that about two-thirds of the subprime mortgages the organization tracks contain prepayment penalties).B. Wall St. [Fn57]. On Banking and Financial Services. [Fn55]. Rev. For the argument that predatory lending is primarily the result of information asymmetry between lenders and borr owers. [Fn58]. 2002).. Rev. [Fn59]. high cost loans an d those based on fraud only where the fraud prevented the borrower from understanding the essential nature of the loan agreement. at http:// www. 1 . [Fn56]. 2001. 1994. Remarks at the Fair Housing Council of New York (April 14. Banking J.impossible Terms. Board of Governors of the Federal Reserve System. A Report from the Coali tion for Responsible Lending 7. Gramlich. May 24. [Fn54]. See generally Edward M. Aug. at 8.

For one of man y examples. 632 (1991). Securitization. Obie Scandal a Costly Lesson for Investors. Celebrity Endorsers and Nontraditional Defendants in Deceptive Advertising Cases. 327 N. severe criticism of its business practices and multiple inquiries. Chi. Jan. 36 Wayne L. For these generally desirable provisions to work properly. Mortgage provisions that are generally desirable. [Fn62]. life.Held Up in Due Course: Predatory Lending. 70 Va." See Consuelo Lauda Kertz & Roobina Ohanian. So was its flameout. Mar. 1994. at 56. and property. 1990. Lloyd Bridges had played "Mike Nelson" on the classic TV show "Sea Hunt.W. Attorney General v. Stars Can Trip Over an Advertiser's Word. Supp. The View from Springfield. Laurie Cohen & Stephen Franklin. 331. . Rev. 1989). 1982).. the number of points and any caps on how much rates or payments can go up each year or over the life of the loan. 603. Mehlberg. As a consequence. [Fn69]. In less than three years. and the Holder in Due Course Doctrine. provisions that work well most of the time end up being abused and hurting vulnerable people enormously some of the time. Jan. Id. [Fn70]. Rev. Then it crashed under the weight of defaulted borrowers.2d 219. Mortgage Banking. George Hamil ton r eportedly said. 1989). a homeowner would need to kn ow the initial (qualifying) rate and how long that rate will remain. A. Obie Scandal a Costly Lesson for Investors. Mar. Mar. the index used to adjust the rate or monthly payment in response to index changes. L. Trib. 1. a t B4. I've been telli ng homeowner s how Dia mond can h elp th em to a better life. are abused. J. Chi. delinquency and default charges." Joanne Lipman..2d 805 (Mich. 1345 (W. [Fn65].E. Rev. [Fn61]. Id. 1994 WL 13436253. Wall St. Laurie Cohen & Stephen Franklin. 220 (Ohio Ct. 728 F. Obie case i n ann ual surveys of Michiga n law. Documents emerging from the investigations paint a picture of a company that skirted the law and government regulations as it aggressively collected high fees on questionable loans in pursuing its goal of being the No. 1990 WL-WSJ 590490. [Fn64]. see Dennis J. 1987. See Diamond/Obie cases cited in Section II(D). Rev. The rise of American Skycorp was stunning. [Fn71]. To compare various adju stable rate mortgages. Sun.D. Levasseur. [Fn66]. Commercial Transactions and Contr acts. Faupel. Childers v. [Fn63].. 1987 WL 2940339. Jerry Demuth. 2001 WL 6147486. Mich. 336-38 (1990). at 1. 2001. or health insurance requirements. but complicated. the Timonium firm soared to the height s as one of the nation's top lend ers of Federal Housing Administr ation . prepayment penalties. ""For many years n ow. O'Donnell. 1190-91 (1992).. 38 Wayne L.J. 1987. Presumably lenders do..backed mortgages. Lender Crash. Rev. Commerce Mortgage Inv. Eskridge. see John B. Maria n L. [Fn67]. 1185. these are the fundamental characteristics of predatory lending. Recent Trends in the Law of Endorsement Advertising: Infomercials. [Fn68]. See Stone v. 1987 WL 2940339. the loan-to-value ratio and mortgage insurance costs. 1341.J. at 1133. 579 N. 35 Creighton L. A. 19 Hofstra L. 1 mortgage lender in the nation. Diamond Mortgage Co.J. Balt. for exampl e. at 1A. both lenders and borrowers must fully understand them. at 1. 22. but often borrowers do not. 9. Id. 503 (2002) Page 69 Apart from outright fraud. In his ads. Trib. Real Property. including at least one fraud investigation. For very brief discussions of the Diam ond Mortga ge/A. 31. 22. Fast Downtown for Md. App.

Id. [Fn78]. Trib. Supp. 878 (Bankr. Trib. at 770. [Fn83]. [Fn81]. 115 (Mich. How Regulators Let 2 Firms Pass.3d 893 (6th Cir. Mar. Mar. at 1345. [Fn74]. [Fn87]. [Fn73]. 1987 WL 2940748. and the Holder in Due Course Doctrine. App. 439 N. 1989). Ct. at 770. 1987 WL 2940433. Ill. P. 668 F. 766. Trib. 931 F. 728 F. 30. Raitt and Heuer. 575 (Bankr. Mercer. Mich. [Fn82]. Stone. [Fn92]. Thomas v.2d 114. 1987 WL 2940433. . [Fn89]. Jordan. 736 F. 1991). In re Diamond Mortgage Corp. Greenberg. No. See also Stephen Franklin & Laurie Cohen. at 1. 1345 (W. 22. 1987. [Fn84].R. Michigan v. at 1345. How Regulators Let 2 Firms Pass. 768 (W. 22.. Bridges. 439 N. and aff'd sub nom.Held Up in Due Course: Predatory Lending. 1991).J.. Schreimer v. 1987 WL 2940339. Securitization. Dia mond-Obie Collapse Hit Little Guy. Mehlberg.2d 336 (Mich. 1982). Mar. 1987). Mar. 135 B. App.D.D.D. 468 N. See.g. Dia mon d-Obie Collapse Hit Little Guy. Chi.D. Aramowicz v. Supp. Mich. [Fn77]. 1989). 118 B. Mar. [Fn80]. Mar. Id. N. Ct. 736 F. 736 F. Chi.2d 805 (Mich.R. v.2d at 342.. 327 N. Mercer v. 22. N. Jaffe. Greenberg. 1162 (N.W. at 1.C. Stone.. Leja. See also Laurie Cohen & Stephen Franklin. Snider.2d at 338.. Supp. Supp. A.2d 1008 (6th Cir. [Fn90]. e. 1987. Ill. 1989) (describing Diamond's scheme). [Fn86]. [Fn75]. aff'd. [Fn79]. Laurie Cohen & Stephen Franklin.W. Greenburg. Diamond-Obie Collapse Hit Little Guy. Rev. Chi. Attorney Gen. 764.W. In re Diamond Mortgage Corp. Apr. 1987 WL 2940433. Laurie Cohen & Stephen Franklin.R.W. [Fn88]. 24. Mercer. 22. Supp. 1987. 463 N. 1987.. [Fn76]. at 1. Greenberg. Diamond Mortgage Co. 439 N. at 84. 1987 WL 2940748. Ill. 24. at 1. 1991).. at 1. Chi. 90-1977. See Ramson v. at 1. Trib. 728 F. [Fn91]. 1987. 1987. 876.W. Layne. Supp. 503 (2002) Page 70 [Fn72]. Trib. Ct. Greenberg. Trib. Mox v. 105 B. Id. Stephen Franklin & Laurie Cohen. [Fn85]. 728 F. Schriemer v. 1989). 35 Creighton L. [Fn93]. 1990) (noting that Diamond failed to pay two senior mortgages).. 59 (Mich..W. Chi. App.. 1990). 1341. 1991 WL 66552 at *4 (6th Cir. 933 F.D. Supp.. 1990). Obie Scandal a Costly Lesson for Investors.2d 58. Chi. Stone v. Stephen Franklin & Laurie Cohen.

[Fn111].2d 840.W. Ct. Rev. App.C. 1990). [Fn116]. Thomas." [Fn100].2d 58 (Mich.C. § 3-305. [Fn115]. [Fn104].C.2d at 115. 1992). See discussion of recourse in Section III(B). [Fn102]. Mich. Ct.W. App. 503 (2002) [Fn94]. Ct. 728 F. U. Ct. 1996. the originator could not claim holder in due course status even though it received an instrument back from a holder in due course if the originator had engaged in "fraud or illegality affecting the instrument. Jordan. Ct.C. Stone v. 841 (Mich. Rev. 494 N. 439 N. § 3-305(a) (2000).2d 840 (Mich. Greenberg.W. Supp. 1341. § 3-302 (2000).W. at E2.W. Id. 468 N. 35 Creighton L. 463 N. Page 71 [Fn95]. [Fn101].W. 439 N.2d at 841-42. 463 N.W. State Mortgage. U. Ct. Thomas v. [Fn113]. Held Up in Due Course: Codification and the Victory of Form Over Intent in Negotiable Instrument Law. [Fn97]. [Fn109]. 1348 (W. [Fn105]. [Fn108].C. Aug. 1341 (W. 1996. at 1347-49. 468 N. 1992).C. Mox v. Leja. Regulators Target Fir st Fidelity Mortgage: Complain t Alleges Firm Fleeced Chur ches. Supp. [Fn106]. 299 (Mich. 494 N. [Fn112].2d 114 (Mich. App. 35 Creighton L. [Fn98]. 728 F. 1989).W. Low-Income People. 439 N. 728 F. Ct. 1989). Bedenfield.2d at 339. Mich.D. [Fn114]. Ct. Aug. [Fn107].W. 1989). 23. [Fn96]. 11. . 1989). Franck. 439 N.Held Up in Due Course: Predatory Lending. [Fn103]. 363 (2002). Pursuan t to U. Securitization. See generally Kurt Eggert.W. App. Mox.W. at A1. 60-61 (Mich. Has Been Charged By FIB For Taking Advanced Payment For Fixing Mortgages That Never Took Place. Stone. at 299-300. [Fn110]. 494 N. 1991). Supp. Det. [Fn117]. Thomas v.2d 58. 115 (Mich. 1991).W. Gary Hoffman.2d 114. Free Press.C. App. Mehlberg. News. App. Franck v. [Fn99].D. App. Officials Detail Fraud Case Again st Mortgag e Firm. and the Holder in Due Course Doctrine. § 3-2 03(b). App. 463 N.C. Det. U. 1990). 299 (Mich.

2000) (finding it objective). noting tha t it h as a subjective el ement . Commerce Mortgage Investments. Payments and Credits 25 (4th ed.W.C. Revised Article 3: Negotiable Instruments [Rev] 3-302:10. Rev. Robert L. we suspect that would be a fair characterization.. 460 N. Budni tz. 203. Credit Union v. Summers. L..W. 460 N.. 220 (1981). [Fn128]. [Fn129].C. referri ng to t he spl it in courts as to h ow to appl y the test. cmt. Jordan & William D. 22 B.2d 232. 727 A. Ct. Rev. of Can." James J. [Fn122]. with some cal ling it object ive and other s.C.2d 335. Courts seem to be split on wheth er the "r easonable commer cial stan dards of fair dealing " test is subjective or objective. Hawkland & Lary Lawrence. [Fn130]. Lary Lawrence. 220. Some courts had refused to consider adjustable rate notes negotiable because they did not have a "sum certain. See Halla v. a claim the court had no difficulty in disposing of. Under U. 43 Mercer L. Elsner v. Rev.22 (Ohio Ct. The court in .2d 232 (Mich. [O]nce the subjective baseline is established either directly or circumstantially. James J. 1999) (citing M. 1995).A. L. Tol.B. Albrecht. In Childers v. Summ ers. [Fn121]. Uniform Commercial Code Series. had the gall to claim that it was not liable for slander of title because it believed it was a holder in due course. Rev.C.A.3d 1113 (Ariz. Rev. the court is able to apply an objective test and to inquire how a reasonable person would have responded to the secondary facts. William D. v. Codification of Negotiable Instr uments Law: A Tale of Reiterated Anachr onism. App. 1997). § 3-302.C . 26 Loy. Warren. § 3-103(a)(4) (2001). L. Brian Blum. Thin king Like a Lawyer. 743 (1993). [Fn120]. 1990). Co. Rubin. Uniform Commercial Code 504 (4th ed. In the first instance it requires a subjective inquiry in or der to establish t hat the person had actua l knowl edge of cer tain seconda ry facts . Securitization. 601 N. For the effect of the exclusion of consumer advocates from thi s process.C. Ct. notice of certain defects in. U. Ct. oth er th an makin g adjustable potential ly negotiable. [Fn124].E. Rev. L. 1999) (finding it subjective) and San Tan Irrigation Dist. White and Summers stated "Whil e we hesitate to label these changes as insignificant. or defenses to. Diamond's alter ego. L. 827 (1992) and Edward L. 659. N.C.Held Up in Due Course: Predatory Lending.W. [Fn125]. we believe th at the ch anges are not significant. L. In discussing the chan ges to Ar ticle 3. 35 Creighton L. 199 5). Me. Var ious comment ators have d iffered as to how fully objecti ve this test i s. What Would Be Wrong With a User-Friendly Code?: The Draftin g of Revised Articles 3 and 4 of the Uniform Commercial Code.W. Uniform Commercial Code § 14-16 (4th ed. App. Id. 654 (1990)). 26 Loy.C. U. 340 (Me. 1990). 1989)." Id..2d 449 (Minn. Wh ite & Robert S. 625. § 1-201(25) (2001). For example. 503 (2002) [Fn118].2d 219. 4 (2001). 579 N. White & Robert S.C. App. Th e Revision of U. App. Wells Fargo Bank. in his article Notice to Holders in Due Course and Other Bona Fide Purchasers Under the Uniform Commercial Code. 670 (1993).C. Ct. . Sinclair. 21 U. 3 P. a note den ies the holder statu s as a holder in due course.A. stat es [T]he test contains both an objective and subjective element. Except for the change i n the sum certain requirement th at makes var iable rat es potential ly negotiable. Childer s v. Articles Three and Four: A Process Which Excluded Con sumer Protection Requir es Federal Action. Norwest Bank Minn. App. Family Fed.C. Commerce Mortgage Invs. [Fn126]. Sun Life Assur. Negotiable Instruments. [Fn123].. U. and the Holder in Due Course Doctrine. [Fn127]. 233-34 (Mich. Acting Like a Lobbyist: Some Notes on the Process of Revising UCC Articles 3 and 4. CMI. see Mark E. § 3-103. Page 72 [Fn119].

2d 335. Fishman eds. 69 Tex. Family Fed. 363. 527. Sun Life Assur. 1 Tama r Fran kel. 503 (2002) Page 73 Hathorn v. Rev. As a result . stating.2 (1991 & Supp.2d 1278. 69 Tex. but not the process as distinct from its product. 35 Creighton L. . Id. 1281 (N. 35 Creighton L. [Fn141]. i n A Pr imer on Secur itiz ation 2 (Leon T. at 375. Ranieri reports that the Wall Street Journal used the word under protest. Mann in Searching for Negotiability in Payment and Credit Systems. L. Law. 342 (Me. Rev. Rev. Shenker & Anthony J. 529 (1995). Leon T . Securitizati on: Stru ctured Fin ancing. representing ownership interests in. L. revisions belies the difficulty in app lying these concepts to the facts of any particular case. see Me. or secured by. Kendall & Michael J.H. 1369. Curren t Issues and New Frontiers. [Fn132]. noting it was a term concocted by Wall Street. 1996). the court underscored the difficulty of applying this change.. [Fn137]. Chief exponent for this argument is Ronald J. 1369. Ranieri. [Fn138]. 726 A. Joseph C. 1999). In Maine Family Federal Credit Union. Securitization. 11 Housing Studies 581 (1996). they give as their definiti on of securitization "th e sale of equity or debt instruments. and Corporat e Reorganization of The Ass'n of the Bar of the City of New York. [Fn140]. 69 Tex. and the Holder in Due Course Doctrine. See Kurt Eggert. refers to an "objective element. and Its Future Potent ial. Whose Interest Rates? Issues in the Development of Mortgage-Backed Securitisation. 1373 (1991) (citation s omitted). Credit Union. of Can. [Fn131]. The auth ors note th at the defin ition is l imited because it describes the final product of the process of securitization. Family Fed. Chairma n of Citicorp. Curren t Issues and New Frontiers." Id. Negotiable In strumen ts Under th e Uniform Commercial Code. income producing asset or pool of assets. Lewis Ranieri claims t o ha ve coined the ter m "securitization" when asked by a Wall Str eet Journal reporter what to call the process for cr eating a new type of mortgage-backed security. Shenker & Colletta. [Fn135]. on Bankr. 50 Bus. 1999). The Origi ns of Securitizat ion. 44 UCLA L. 951 (1997).. Asset Securiti zation: Evolution. Laurence Murphy. Rev. See Lewis S..2d at 342. [Fn133]. Structured Financing Techni ques. more liquid than ownership interests in and loans against th e underlying assets. Rev.C. Address at the Kellogg Graduate School of Management). [Fn134].C. [Fn136]. For a sim ilar analysis. thus. in a transaction structured to reduce or reallocate certain risks inherent in owning or lending against the underlying assets and to ensure that such interests are more readily marketable and. Loftus. Kendall. Held Up In Due Course: Codification and the Victory of Form Over Intent in Negotiable Instrument Law. Fina ncial Asset s Pools. Co. Secur itiz ation : A New Er a in American Fina nce.04[2] (1997) (emphasis added)." Me.Held Up in Due Course: Predatory Lending. The newspaper treated Wall Street's coinage of the n ew word with the sa me lack of respect Jud ge Holt had sh own Lombard Str eet's creati on of a new form of negotiable instruments. Credit Union v. § 11. Willier . Rev. in A Primer on Securitization 31 (Leon T. See discussion of the central purposes of the holder in due course rule in section IV of Eggert. 2 Frederick M. Rev. Kendall & Michael J. 35 Creighton L." which seems an attempt to find a middle groun d. and Asset -Backed Securities § 1. The Comm. L. Shenker & Anthony J. "Unfortunately. 727 A. Fishman eds. Sources of Its Gr owth. at 1380. 727 A. 1996) (quoting John Reed. Id. 1379-80 (1991). a segregated. Joseph C. Asset Securiti zation: Evolution. [Fn139]. 387-88 (2002). Colletta. or in conveying them to a jury. the ease with which the distinction between 'fair dealing' and 'careful dealing' was set forth in the comment s to the U. Hart & William F. Colletta. 2000).

74 Wash. and Corporate Reorganization of The Ass'n of the Bar of the City of New York. See Dominick A. The Secondary Mortgage Market a Catalyst for Change in Real Estate Transactions. see Robin Paul Malloy. Ill.S. [Fn151]. Rev. [Fn146]. 1. Table funding is very confusing for borrowers. While th ey may be free of the ri sk of default by the originator. A39 tbl. Schill. 541. at 271 (citing Mortgage Debt Outstanding. L. 9 Am. at 71. Ahern. 50 Bus. 73 Fed. Id. 84 Fed. See Student Loan Mktg.3d 397. affecting the securities depending on how sensitive they are to prepayment rates. 923. See also Joint U. Bus.Held Up in Due Course: Predatory Lending. These GSEs were created by Congress lar gely to sup port t he secon dary market for residential mortgages. Securitization of Financial Assets § 16. Even mort gage backed securities issued by the most risk free GSE ar e not themselves risk free. Michael H. and the Holder in Due Course Doctrine. Ma rshal l L. 1997) (discussing the securitization of student loans). Roberta Romano. [Fn147]. III. Claire A. The Alchemy of Asset Securitization. 55 Md.--U. [Fn154]. Rev. [Fn145].hud. Res. Bull. 1 Stan. Reinventing the Government Corporation. Yuliya A. Securitization.J. Lawrence R. The Impact of the C apital Markets on Real Estate Law and Practice. Curbing Predatory Home Mortgage Lending 39 (June 2000). 583 (1995) (observing th at the str ategies an d purposes of Fann ie Mae and Fr eddie Mac ha ve so converged that they have essentially become competitors. U. See A.pdf (last visited Mar. Rev. 32 J. 1998)). Rev. For a discussion of the extent of government ownership and r egulatory scrutiny of these GSEs. 69 (1996). Bull. Assn v. Riley. Res. 2002). Hill. Securitisation: An International Perspective 30-31 (1995)).1. Law. 115. 269. 1106 (1996). Page 74 [Fn143]. J. [Fn152]. 38 Hous..S. L. at 529. [Fn150]. though the funds for closing the loan are provided by a different lender and the loan is usually assigned to that different lender almost immediately. The Comm. A Thumbnail Sketch of Derivative Securities and Their Regulation. Inst. 50 Bus. "Workouts" Under Revised Article 9: A Review of Changes a nd Pr oposal for Study. and Corporate Reorganization of The Ass'n of the Bar of the City of New York. 39 Sw. Kravitt ed.04[A] (Jason H. that GSEs are safe because either they are too large to fail or the United States government would not allow th em to fai l. at 1380-81. 1997). Marshall L.54 (June 1987)). Michael Froomkin. as t he ma rket assumes tha t the securities are implicitly guaranteed by the feder al gover nmen t or at least. 32 J. if not entirely redundant). 133. 1061. L. 1995 U. Securitization : A Low-cost Sweetener for Lemons. Rev.L. A35 tbl. with the hope that this support would reduce interest rates. Thompson. at http://www. L. Cir. Securities issued by GSEs are perceived as relatively risk-fr ee. See Steven L. 573 (2001) (citing John K. Dvorak. [Fn148]. The Comm. L. at 529. Id. [Fn144]. Transplanting Asset Securitization: Is the Grass Green Enough on the Other Side?. Rev. 123 (2001). on Bankr. Dep't of Housing and Urban Dev. 1001-02 (1986). [Fn153]. they still can contain sizable risk that interest rate or other economic changes will substantially alter the prepayment rate.P. 271 (1999) (citing Mortgage Debt Outstanding. Id. Id. 2d ed. 114 Banking L. 1. 503 (2002) [Fn142].Q. Schill. L. 9. 35 Creighton L. 991. Bankr. [Fn149]. on Bankr. Schwar cz. typically a mortgage broker. 936 (1997).C. 138-41 . at worst. Mazzagetti.gov/library/bookshelf18/pressrel/treasrpt. Comment. Dealing with Mortgage Loan Brokers: Legal and Practical Issues. 543. Rev. & Fin. 104 F. Law. 399-400 (D. Dep't of the Treasury Task Force on Predatory Lending.J.54 (Aug. "Table funding" is the process whereby a loan is closed in the name of an originator.

Langbein.J. 434. Rev. 74 Wash.Q. 1247 PLI/Corp 529. i n A Pr imer on Secur itiz ation 4 (Leon . The purpose of the SPV is three-fold: First. 172 (1997). The multi. and the decreased risk that a single originator's bankruptcy might affect the business entity holding the assets. t hat borr owers do not always refin ance when i nterest r ates have dr opped sufficiently to make it economically reasonable to refinance.33. L. Third. it provides a means for the illiquid assets to be pooled and transformed into liquid securities. It is imp ortant to note. Lan gbein. a partnership or a limited liability company. Securitization of Executory Future Flows as Bankruptcy-Remote True Sales. John H. L. Kenneth G. 67 U. L. [Fn158]. Cowan. U. Real Est. The above description is a simplification of the complicated world of securitization. Due Diligence in Asset-backed Securities Transactions. 73 N. Th e Secret Life of the Trust: The Tr ust as an Instrument of Commerce. See Robert Dean Ellis. [Fn156]. Gordon. Leon T . Hill. 301 n. Chi. Securi tization: Asset-Backed an d Mortgage-Backed Securities §1.Held Up in Due Course: Predatory Lending. at 1069 n. On th e one hand.Q. Mortgage-Back ed Securities: Developments and Trends in th e Secondary Mortgage Market 6-34 to -35 (2000). Hill. 105 Yale L. Fin. it protects the investors from claims of the originator's creditors or other third parties. SPVs can be REMICs ("Real Estate Mortgage Investment Contracts") or FASITS ("Financial Asset Securitization Trusts"). [Fn155]. Secur itiz ation : A New Er a in American Fina nce. 13 J. 1317. For a contractarian view of the law of trusts. a corporation. Second. Gordon. Maris & Tyler T. and a multitude of other forms. Kendall. SPVs are dual in nature.. 625 (1995). Yang. which are different forms of entities under the tax code. 295.seller securitization conduits have the benefit of economies of scale. they may also have an identity under the federal tax code that provides favorable federal income tax status. which separate the interest and principle payments into separate strips. in that exactly what the SPV transfers to the seller may depend on the form of the SPV and how it is set up. The Contractarian Basis of the Law of Trusts. such as a trust. Cowan. L. Rev. Id.05 (A)(1) (Ronald S. 469 (1998). Borod describes a "continuous flood of innovations in the structuring of mortgage securities. they typically are in the form of a business entity defined under state law. while the "one-off" securitizations have the advantage of allowing the originator to tailor the securitization to the originator's particular needs. The Functions of Trust Law: A Comparative Legal and Economic Analysis. [Fn164]. it protects the investors in the SPV from bankruptcy by being an entity highly unlikely to become bankrupt. 67 U. 24 J. Lore & Cameron L. Rev. Securitization: A Low-Cost Sweetener for Lemons. Henry Hansma nn & Ugo Matt ei. if the SPV is a corporation.U. 74 Wash. 1321-23 (2000). and the Holder in Due Course Doctrine. discussing the development of the trust from a means of conveyance to a structure for management. 187. On the other hand. Fiduciary Duties. Katz." including stripped mortgage-backed securities. Lore & Camer on L. 1247 PLI/Corp at 534. see John H. Cor p. [Fn160]. 6-115 to -117 (2000). however. Securitiz ation Veh icles. See also Thomas J. and Bondh olders' Righ ts. 187-88 (1996). since it serves mostly as a conduit for an income stream. Borod ed.Y. 165. [Fn157]. [Fn159]. See Claire A. those where all of the assets come from one originator. Brian A. Katz. Interest-Only and Principal-Only Mortgage Strips as Interest-Rate Contingent Claims. where a number of originators use a common business entity to hold the assets to be securitized).32 (1999). Securitization. 35 Creighton L. the investors may purcha se debt obligations rath er than securities. For example. 503 (2002) Page 75 (1994) (discussing "one-off" securitizations. as compared to multi-seller securitization conduits. 1999). Mortgage-Backed Securities: Developments and Trends in the Secondary Mortgage Market 6-32 to -35.J. 534 (2001). 1061. 1068-69 (1996). & Econ. Chi. See Kenneth G. [Fn162]. L. U. 107 Ya le L. Andrew E. L. at 1322-23 (2000). [Fn163]. [Fn161]. Rev.

1247 PLI/Corp 529. at 6367. 126 F. v. Dec. 1 Stan.D. SF11 ALI-ABA at 69. 534-35 (2001).. Andrew E. at 7. Due Diligence in Asset-backed Securities Transactions. or some combination of them? She con cludes that this qu estion may deter mine whether th e securities n eed be registered . See.g. N. 407. Bus. Katz. of La. Schwarcz. 22. Asset Sec.3d 1478. though in this case. Inc. L. [Fn165]. Rep. Inc. United Fin. [Fn172]. L. Lending Corp. Rev. 1482 (5th Cir.N. Lois R. McDaniel. Fishman eds. [Fn167]. J. Rev. U. but also gives the ori ginator an increased and extended incentive to monitor the assets an d th eir per formance. 1067-68 (1996). Revised Article 9. for the record keeping used to track the sales of Ginnie Mae-issued securities to the ultimate investors. T he Impact of Dilution in Asset Securitization: Commercial Separation Anxiety. 1997). "Deep mortga ge insurance. 313 (2001). No. Th e Alchemy of Asset Securitization. N. In that case. 104 F. 1 Stan. L. 9 Am. the sponsors of the securitization process. 133. [Fn174]. L. Jan. See Alan P. 97 C 3257. th e investor claimed tha t these were fraudulent pr omises. Bus. in which the subprime lender. 20 F. [Fn170].. 2001 WL 15747038. t he cour t refused to dismiss a clai m for implied indemnificat ion where SMFC had also pled a cl aim for express indemnification. v. 144 (1994)). [Fn171]. [Fn175]. Bankr. though the lines between securitization and factoring can blur when the buyer actively negotiates the transaction terms. v.47 (3d Cir. 2001. Supp. Some private placements are sold directly to investors without the involvement of an underwriter. Tamar Frankel discusses an interesting issue in securitization. 2001 WL 9321852." which covers a greater percen tage of each loan. 136 (1994).L. Id. e. 503 (2002) Page 76 T. Schwarcz. 1997). and depended on in flated valuations of the under lying properties. Ill. Securitization Transactions and the Bankruptcy Dynamic. 2001. Citicorp. 1997). & Fin. 419 (1996). as well as a method of perpetrating fraud in such an issuance. 2d 192 (D. 1996). 66 Miss. Securitization: A Low-Cost Sweetener for Lemons. Bus. 146.3d 1478 (5th Cir. Rod Dubitsky. 1998).. 133. Claire A. Has Securitization Increased Risk to the Financial System?. apparent ly attempted to justify its high interest rates by argui ng tha t it had to buy back defaulted loans. May 14. Mass.3d 144. Hill. [Fn169]. See also Trust Co. 74 Wash. SF11 ALI-ABA 69 (2000). Lupica. Sargeant. [Fn173].. Mortgage Corp. 35 Creighton L. and the Holder in Due Course Doctrine. [Fn176]. The Alchemy of Asset Securitization. & Fin.N. See Trust Co. v. McDaniel. Steven L. Q. [Fn166]. Steinhardt Group Inc. at *1 (N. K.P. Derri ck Allen Dyer.Held Up in Due Course: Predatory Lending. of La. Apr. 1. Id. 2001 WL 8009587. v. in which the Seller/Servicer Guide adopted by the securitizer of mortgage loans requires an originator to buy back any loans where any person involved in the loan transaction made any misrepresentations or pertinent omissions in connection with the loan transaction. 104 F. 287. 1997 WL 798780. namely who is in fact the issuer of the securities that result from the process: the SPV that is formed. 1997). 16. Deep Impa ct: The Effect of Deep Mortgage Insur ance in the Home Equity Mar ket. Hill notes that securitization differs from factoring. the trustees or servicers of the SPV. 2001. Mu rray. at 1068 n..J. [Fn168]. Impact of Securitization and Conduit Financing.29 (citing Steven L. "Deep MI Coverage" Gains Favor. See United Cos. J.C.P. Securitization. Ken dall & Michael J. 1061. Econ. regar ding th e value of the guar antee pr ovided by Ginnie Mae.. Nat'l Mortgage News. United Compa nies. See also SMFC Funding Corp. in which th e promise was made that an investor in such a securitization of delinquent and foreclosed loans could receive annual returns of eighteen percent or more an nually. Inst. Such participation by the originator not only forces the originator to take the first loss. is increasingly relied on in subprime securitizations.

at 135. threatened to challen ge the belief that the securitiza tion process could render assets "bankruptcy remote" and thus unattachable in the bankruptcy of the original owners. See generally Lois R. which attempted in bankruptcy court to undo two of its own securitizations. Mortgage Banking Unbundling: Str ucture. Judgment Proofing.. U. Rev.J. The Rotten Foundations of Securitization. Circumvention of the Bankruptcy Process: The Statutory Institutionalization of Securitization. Lupica. 33 Conn. Jr. and (3) wh o contr ols th e collection on and the admin istr ation of accounts. See Tamar Frankel. the most important factor the courts will look to is whether the tran sferee h as an y recourse against the tran sferor should there be problems with the assets. Castle Credit Corp. To determine whether the transfer of the assets to the SPV constitutes a true sale.. L. Mooney. But see Steven L. at 15:35:00. 387. 1. Structur ed Finan ce: The New Way to Securitize Assets. with a set discount reflect ing the difficulty in obtaining full value for the asset estimat ed at the time of the transfer. L. Asset Sec. Mar. [Fn182]. 11 Cardozo L. 602 F. the transferor or transferee. [Fn178]. citing Octagon Gas Systems. with Pr ofessor Lopucki's repl y to Schwarcz. LTV Ruling Challenges Legal Basis for Securitizations.). 2001. 503 (2002) Page 77 under the Securities Act of 1933.J. 2001 WL 8009503. Jacobides. 107 Ya le L. John H. 995 F. Schwarcz. 173 n. 1979)). [Fn177]. 52 Stan. Lynn M. See also the discussion of bankruptcy remoteness and the possibility of circumventing the bankruptcy remote provisions in the bylaws of corporate debtors who issue mortgage backed securities through collusion between the debtors and "friendly" creditors in Michael J. 92 n. Th e Secret Life of the Trust: The Tr ust as an Instrument of Commerce. J. one backed by inventory. See David P. Henry Hansma nn & Reinier Kraakman . 2001. 35 Creighton L.127 (1996) (arguing that securitization is a method of judgment proofing even for defendants with a stream of in come). Michael G. see David Gray Carl son. Mortgage Banking. 929 (1998). 545 n.2d 948 (10th Cir. L. Rev.J. 12.49 (1997). Automation and Profit. the other by trade receivables. Securitization. Lan gbein. 52 Stan. see also Steven L. Inc. Asset Securitization: The Unsecured Creditor's Perspective. LTV's act ions. Hill. 1055 (1998).L. 607 (1990).1. L. 1993 Colum. Rev. or may be exempt as bank obligations. For a description of the un easy relationship between securitiz ation an d the bank ruptcy process. Rev. (2) wheth er the pr ice paid for th e asset is adjustable. Schwarcz. & Mary L. Bus. Th e Inh erent Irr ation alit y of Judgmen t Proofing. Lupica. 106 Yale L.Held Up in Due Course: Predatory Lending. at 1073. L. Cap. L. or has a righ t to an y surplus generated by the asset over and above the return promised to th e transferee. 73 (1999). 1 (1999). Rev. Bank. or fixed. Securitization: The Conflict Between Personal and Market Law (Contract and Property). 197. LTV's Threat to Securitization--Is It Over or Just Beginning?. 110 Yale L. Rimmer (In re Meridian Reserve. 1993). 216 (1999). 55 (1999) and Schwarcz's rejoinder. L. Feb. 74 Wash. Bus. Rev. [Fn181]. 199 (2000). Rev. The Essential Role of Organizational Law. Phillips. 76 Tex. The Death of Liability. Jacob & Joshua P. 2001 WL 28402001. Rep. such as in the quality or collectibilit y of a loan. L. Judgment Proofing: A Rejoinder. v. 18 Ann. Schwarcz gives as the other important factors to determine whether a true sale has occurred the following: (1) Whether the originator has the r ight to redeem or repur chase the a sset aft er it has been tr ansferred. & Fin . Rev. at 146-48. 52 Stan. Jan. 77 (1999).Q. Id. 165. 421 (2000). Bankruptcy Policy. 39 Wm. 39 Wm. Lopucki. Charles W. and especially dicta therein. and the Dark Side of Tort Liability. [Fn180]. Rev. Cohn. Rep. & Mary L. 595 (1998). Inc. L. Carlson. Lois R. buttr essed by an in itia l Memor andum Opi nion by the tr ial judge. . Though it later withdrew it s attack on the securitizati ons after an out of court settlemen t. 16. Note. Rev. 26 Hofstra L. The Parts Are Greater Than the Whole: How Securitization of Divisible Interests Can Revolutionize Structured Finance and Open the Capital Markets to Middle-Market Companies.. 145 (1993) (citing Major's Furniture Mart v. St even L.2d 538. fluctuatin g like a commercia l loan . Lopucki. Sch warcz. at 1059. [Fn179]. Rev. David Feldh eim.. Th e Irrefutabl e Logic of Judgment Proofing: a Reply to Professor Schwarcz. 139. The basic underl ying concepts of securit ization have been thr eatened in the bankr uptcy of LTV Corporati on. 2001. Mkts. 52 Sta n. and the Holder in Due Course Doctrine. Car lson a rgues tha t the securitiz ation process should not r ender accounts or chattel paper bankruptcy remote.12 (3d Cir. Schwarcz . Rev. 1 Stan. Lynn M. Steven L Schwar cz. Asset Securitization: How Remote is Bankruptcy Remote?. Rev.

& Fin. Bernstein. J. Mortgage Banking. L. [Fn189]. its capital structure is irreleva nt to the value of th e firm. seems to be viola ted by the idea t hat securi tiza tion can increase th e value of assets held by a firm. 1 Stan.L. Reserve Bank Atlanta). Kaufman Winn. 101. giving the borrower an opportunity to pay the outstanding balance to the lender. 1990). Claire A. 2001 WL 4546967 (referring to the Fitch rating system). Schwarcz. but free of junior liens and the borrower's interest. Rev. See FDIC v. [Fn192]. Any funds received at the sale are disbursed in the following order: first to the borrower's indebtedness to the lender. Rating Agencies Gear Up for More Scrutiny. 20. 2001 WL 10529705 (noting that the increase in subprime lending has led to a demand for servicer ratings). 2001. at 1073. Professor Hill notes that the Modigliani and Miller capital structure irrelevance theorem. 695 (2000). Nov. CV 89-2080. Sally J. and refers nonperforming loans to a special servicer. L. Real Est. [Fn185].A.A. 295. 2001 WL 28402001. Jane Kaufman Winn. Fannie Mae and Freddie Mac at Work in the Secondary Mortgage Market. Mortgage-Backed Securities Letter. Asset-Securitiz ation and Corpor ation Risk Allocation. 146 (1994). 2001 WL 18971203. L. No. Securitization: A Low-Cost Sweetener for Lemons. 35 Creighton L. See generally Michael Padhi. U. to the borrower. Although many mortgage-ba cked securities ar e not subject to the feder al regulations imposing duties on most trustees. [Fn186]. 1 Stan. at *3 (E. 133. Jacobides.. July 17. & Econ. Jan. Frost. for the protect ion of investors. Securitiz ation: Asset-Backed and Mortgage-Backed Securities § 8. U. The Effects of Securitiza tion on Mortgage Market Yields: A Cointegration Analysis. [Fn187]. 302 (1999). 1990 WL 198738. the lender gives notice of foreclosure. 1063-64 (1996).1. 133.N. SE76 ALI-ABA 673. 26 J. 1061. 541. advances late loan payments to the trustee.01(A) (Ronald S. L. 1991). Frank Musero. 136 (1994). the trustee mu st step in a nd remove th e servicer. 690 (1998). Securitization. 2001. in other words. 1. and the Holder in Due Course Doctrine. 503 (2002) Page 78 [Fn183]. Schwarcz. & Fin. at 592. the standard American foreclosure process is the following: After default by the borrower. while in pr ivate p ractice. If the lender does not receive this payment. rating agencies maintain their own minimum standards for trustees and the amount of capital the trustees mu st main tain. L. if any funds remain . h elped develop securitization and remai ns one of its foremost advocates. the r isk of defaults ha s only a wea k effect.Q. Lien Stripping After Nobelman. J. Fin. Bus. Id. Robert Dean Ellis. Rev. While specific practices vary from state to state. Jan. L. 2001. Fiduciary Duties. If the servicer defaults on its obligation to pass loan payments on to the holders of the securities. which states that a firm's division of cash outflows between one or more layers of equity or debt. Schwa rcz. 105-06 (1997) (questioning whether securitization merely reallocates risk to other creditors rather than lowering a firm's overall capital costs). Securitiz ation Veh icles.Y. aff'd. James W. Hill. Th e buyer at the publi c sale takes title to the property with it still encumbered by liens senior to the foreclosing lender's. [Fn193]. the lender may obtain a public sale of the real property securing the loan. Fitch Rates RFC Top Loan-Master Servicer. Ted Cornwell. Glossary of Terms Commercial Mortgage-Backed Securities. and last. 677. next to an y junior lien holders. 1997). [Fn184].2d 101 (2d Cir.Held Up in Due Course: Predatory Lending. 27 Loy. Kolari. and Bondh olders' Righ ts. Borod ed. L. But see Christopher W.D. 72 Tul. 2001.L. 74 Wash. 27 Loy. Update (Fed. Apr. Hill. Id. 74 Wash. A recent study has concluded th at while prepayment r isk has a moderat e effect on interest rates. Steven L. 24 J. Fin. [Fn188].Q. Cor p. Bus. 2. 944 F. L. Th e Alchemy of Asset Securitization. [Fn190]. a sale conducted either by an agent of the lender or under court supervision. A master servicer collects loan payments and transmits them to the trustee. [Fn191]. 592 (1994). Gordon. Fraser & Ali An ari. Rev. Rev. Donal d R. Mortgage Servicing News. . gives pool performance reports to the holders of securities.

Chase W.10-5. Seymann. 253. 47 Consumer Fin. Banker . [Fn205]. "The possibility that regulatory capital ratios may mask true insolvency probability becomes more acute. Rev. See Chris De Reza. Robin Paul Ma lloy." Schwarcz. an d may feel free essentially to take the money and run. 503 (2002) [Fn194]. [Fn202]. See Mark L. Id. [Fn197]. Bus. June 18. 2001 WL 15747038 (noting that securitization erodes barriers to entry in the financial industry).2. Oct. for example. J. in A Primer on Securiti zation 9 9-100 (Leon T. Securitizati on: Stru ctured Fin ancing. 2001. The Secondary Mortgage Market: A Ca talyst for Change in Real Estate Tran sactions.Held Up in Due Course: Predatory Lending. 26. at § 5. 1 Stan. Id. [Fn204]. [Fn206]. Its Cr editors Face Higher Risks... Schwarcz notes that securitization is especially suspect where the originator is near bankruptcy. Ed. J. 35 Creighton L. with only the short term goal to deceive and defraud as many borrowers and investors as possible before folding. [Fn196]. [Fn199]. Bus. Schwarcz.L. the ban kruptcy trustee discovered that the investors were identified by number only.. 991. Cor p. The abili ty to tur n receivables int o ready cash also creates the ri sk that th e cash received is li kely to be quickly dissipated. Today. at 8. [Fn198]. Schwa rcz's response to t his a rgum ent is tha t "given th e scrut iny imposed by ratin g agencies and other independent par ties such as cr edit enh ancers.. 24 J.11. and the Holder in Due Course Doctrine. 2001 WL 8192517. Frankel. Am. [Fn203]. Real Est. The article notes that this ability of banks to reduce the amount of capital t hey must hold by securitizing th eir safer loans. Bus. Fina ncial Asset s Pools. & Fin. Bus. Fin.11 (1991 & Supp. 1 Stan. L. at 151. Fiduciary Duties. Id. The Workings of Private Mortgage Ban kers and Securitiz ation Con duits. at 4. 1. Elec. Wk. During the year 2000. Murray. Ed. 2001. Jan. at 6367. 295.Q.2. Securitization is No Security Blanket. Structured Finance Upgrades Break Records. at 147. After the company at the hear t of the scheme decla red bankr uptcy. and Bondh olders' Righ ts. 1 Tama r Fran kel. Rep. due to the strong econom y. Comment. 29. become more concerned about information regarding individual loans in the pools and securitizers are forced to disclose more and more data on those individual loans. at § 5. presumably because the originator no longer has an y fear of ratings agencies or oth er part ies at tha t stage. Econ. investment houses issued 510 different upgrades to the highest quality mortgag e-backed securities. 302 (1999). Kendall & Michael J. with seventy-one downgrades and only . Allegations Fly in Securities Fraud Case. Ash ley. However. L. at 5. 2001. Elec. would have a similar freedom from fear of the long term effects of ratings agencies. This efficiency is declining. 2001 WL 8192961 (descr ibing an alleg ed fraudulent mortga ge backed secur ities scheme that may have cost investors $214 milli on). [Fn200]. Fin.J. L.11. Jan. Robert Dean Ellis. Securitiz ation Veh icles. actually erodes the ability of bank regulators to ensure the financial stability of banks. Page 79 [Fn195]. 1998. 254 (1993). and quotes Alan Greenspan stating. Korell. 2000). Has Securitization Increased Risk to the Financial System?. perhaps burned once too often by declining ratings in mortgage pools. supra note 201. as investors.. Marilyn R. subprime loans did much less well despite the thriving economy.. 1996). See Chris De Reza. Banking's Role in Emerging Secondary Markets. Securities backed by lower quality. securitiz ation ma y present fewer opportunities for self-dealing than other financing methods. 1993 . 39 Sw. 1016 (1986). and Asset -backed Securities §§ 5. Securitization. Disreputable companies. When a Comp any Securitizes. May 7. Alan P.L. Real Est. Today. Fishman eds." [Fn201]. and alleged that some overseas investors were engaged in money laundering and tax evasion. whil e retainin g their ri skier loans. & Fin.

12. & Roger Sparks. Real Est. E-Loan Boasts Upgrading For 2-Minute Application. Unsurprisingly. then more of the homeowners whose loans are part of the pool will likely refinance. Id. Fraser & Ali An ari. [Fn208]. at 685. Credit Scoring and Mortgage Securitization: Do They Lower Mortgage Rates? Federal Reserve Board Paper 2000-44. high level expertise. though originators still have the "fir st mover advantage" of deciding what loans to securitize. Donal d R. 677. Mortgage-Backed Securities: Developments and Trends in the Secondary Mortgage Market 2-30 to -39 (2000). 2000. In the later study. 35 Creighton L. Passmore and Sparks paper. for example.federalreserve. 546 (1989). announced in August 2001. Aug. 2001). 1996). Id.gov/pubs/feds/2000/200044/200044abs. [Fn207]. 2001 WL 8192961. 26 J. Real Est. Funds available consistently. Today. 12." Id. Lore & Cameron L. Kolari. Leon T. an internet lender. Lower costs of funds 2. Securitization. at. Puttin g the Squeeze on a Ma rket for Lemons: Government-Sponsored Mortgage Securitization. Dec. 2001). If. Kenneth G. Rev. Am. Frankel. and the right software to determine and verify both the underlying assumptions on which the securities are based and their price. Rev. 2001. C ompetitive rates and ter ms n ation ally and locally 4. Frankel also details other risks to investors. [Fn209].federalreserve. 2001 WL 26573189. supra note 201. Economic and Regulatory Developments Affecting Mortgage Related Securities.html (last visited June 17. at 5. Fin. & Econ. Ed. Kendall & Michael J. The r atin g of the pool can also be ch anged through market forces separate from the pool itself. Dec. at 12. Dec. Fin. Elec. Fishman eds. Credit Scoring and Mortgage Securitization: Do They Lower Mortgage Rates?. . Real Est. the GSEs have attacked the Heuson.11. Heuson. See Chris De Reza. 2000. James W. and An ari repor t sign ifican t decrease in yield spr eads. 497. 2000 WL 8249712.gov/pubs/feds/2000/200044/200044abs. Kendall. Fed Report Says. 12. do not universally demon stra te that securitizat ion lowers borrowers' loan or costs. Pittman. Fin. Rev. [Fn211]. 503 (2002) Page 80 twenty-five upgrades. However.. Wayne Passmore. Wayne Passmore. 679 (1998 ). and even som e of these auth ors' own data seems to contradict the results of their study. They may require full information on what the Pools contain. and Sparks assume that new credit scoring approach es have largely elimina ted this information asymmetr y. Fin. in A Primer on Securitization 2 (Leon T. Leon T. 2001. Fraser. stating. The Effects of Securitization on Mortgage Market Yields: A Cointegration Analysis. and the Holder in Due Course Doctrine. "asset-backed securities can be complex. Increased buffet of credit forms 3. the securitization process may actually increase interest rates). http:// www. at http://www. that it had reduced its loan application process to roughly two minutes. at § 5.2. Andrea Heuson. [Fn213]. Securitization: A New Era in American Finance. 13 J. at 3. Kendall lists as securitization's benefits to consumers/borrowers the following: 1. 64 Notre Dame L. & Roger Sparks. [Fn210]. & Econ. Federal Reserve Board Paper 2000-44. June 18.Held Up in Due Course: Predatory Lending. Securitization Does Not Lower Rates. [Fn212]. arguin g that it is based solely on a model of "a hypoth etical mortgage mar ket based on a flagr antly unr ealistic assumpt ion. interest rates drop more than expected. See also Wayne Passmore & Roger Sparks. Cowan." Mike Sorohan." and "contains not on e shred of data or evidence. t hough gener ally support ing their conclusion . a s securitiz ation incr eases. 2000. As an example of how automated underwriting ca n become. Today. Pittman. 27 (1996) (arguing that where there is information asymmetry between the originator and the securitizer.. Banker. Passmore. Real Est. the differen ce between the effect ive interest rate on home loans and the interest rate generated by Treasury bills with an average maturity equal to that of the h ome loans. the studi es surveyed by these a uthors. Allegations Fly in Securities Fraud Case. Kolari. 14. and early refinancing disrupts the flow of income to the pool. Edward L. Andrea Heuson. E-Loans. 64 Notre Dame L.html (last visited June 17. at 546.

[Fn219]. Mann. 1.J. Dep't of the Treasury Task Force on Predatory Lending. Ten Easy Ways to Make A Loan Nonsecuritizable. Bad Loans Made Good.hud. Jacobides. [Fn216]. 923. 107th Cong. Senate Comm. Wk. . Automation and Profit. Dealing with Mortgage Loan Brokers: Legal and Practical Issues. 1998.. 27. [Fn223]. [Fn222]. 35 Creighton L. Ed. but at least. headquartered in West Palm Beach. Bus.000 independent regional bankers and brokers from across the country as of 1998. July 27. Curbing Predatory Home Mortgage Lending 40 (June 2000).gov/library/bookshelf18/pressrel/treasrpt. Securitization. Posner. 1. Debra Sparks.htm (la st visited Feb. Economic Analysis of Law 127 (Aspen 5th ed. Oct. Rev. Mortgage Banking. Predatory Mortgage Lending: The Problem.gov/01_ 07hrg/07 2701/fendly. Rev. Jan. [Fn215]. Chris De Reza. 2001). Elec. 2001 WL 11398425. Ocwen Financial Services. Mortgage Banking Unbundling: Str ucture. 106th Cong. at 128." Id. 197. 2002).pdf (last visited Mar. 2001. 2002). Mazzagetti. Banking L. which deals with commercial loan s. at http://ban king. Jan.40 (1997). Securitization: The Conflict Between Personal and Market Law (Contract and Property). 1997). 9. Jacobides writes. Searching for Negotiability in Payment and Credit Systems. The stand ardizati on of loan documents is so importan t to loan securitiza tion that fail ing to use stand ardized documents is one of the ten ways to mak e a loan nonsecuritizable li sted in the ar ticle Maura B. 11 (2001). 44 UCLA L.senat e. 1998 WL 19884632. 26. was reported to acquire mortgages from roughly 1. through their m arket dominance. See Ronald J. Joint U. Jacobides. (2000) (testimony of Neill Fendly. [Fn217].Held Up in Due Course: Predatory Lending. these documents have become the industry standard). and the Holder in Due Course Doctrine. a few individual consumers can express displeasure at par ticularly har sh form contract ter ms. Nat'l Ass'n of Mortgage Brokers. O'Connor & James Bryce.--U. Mortgage Lending Abuses: Hearing Before the House Comm. Jan. can operate with little or no overhead. Nat'l Assoc. 114 Banking L.S. [Fn220]. at 1. Today.S. President-Elect. 503 (2002) Page 81 [Fn214]. Rev. Jacobides. On Banking and Financial Services.S. [Fn225]. 2000 WL 19304105. 951. (2001) (testimony of Neill Fendly. "The mortgage bank ing indust ry is one of the most fascinating examples of vertical disintegration and reconfiguration in modern business history. [Fn224]. Housing. 1. 18 Ann. See Tamar Frankel.. 2001. Fin . in The Recent Evolution of Financial Systems 128 (Jack Revell ed. Richard A. and can disappear quickly if difficulties arise. [Fn218]. 971 (1997) (regarding th e GSEs' promulgation of standar dized documen ts and h ow. For example. Fan nie Mae. Fr eddie Mac Agree to Common AU Stan dard. of Mortgage Brokers. 2001 WL 11398425. which may lead a seller to change those terms. at http:// www. 2000). Eli sabetta Mont anaro. 939. 2001 WL 8193092. Efficien t Risk Managemen t in Fina ncial Systems: Universal Bank or Securitisation. Dep't of Housing and Urban Dev. 202 (1999) (noting the seven stages of the securitized loan process). Impact and Responses: Hearing Before the U. I think it is questionable whether many sellers have sufficiently captured t he mar ket using better form cont racts to force oth er sellers t o change th eir form cont racts in response. Mortgage Banking. [Fn221]. [Fn227]. 2001. Real Est. in t he absence of an industry-wide standa rdized contra ct. Given the rarity of consumers actually reading and understanding form contracts. 470 PLI/Real 11. 2001 WL 11398425. past President.. on Banking. [Fn226]. and Urban Affairs. "Mortgage brokers do not have as much invested in their company [as mortgage bankers]. July 23. Michael G. 2001. May 24." Dominick A. 1998). Mortgage Banking.

L. 2001. in Durh am. 35 Creighton L.pdf (last visited Mar. Keest. Joint U. 2001.gov/library/bookshelf18/pressrel/treasrpt.). Daugherty. Crain's Chi. . Kathleen E. (2001) (testimony of Neill Fendly. Kyriaki Venetis. 2002). [Fn241]. 1998. 4 N. 1737. Dep't of Housing and Urban Dev. Banking Inst. 1998 WL 18887995. 2000 WL 8130226 (quoting Ben Israel. Securitization.C. Myron Levin. 1241 PLI/Corp at 1135. [Fn229]. 2002). L. Joint U. June 13.htm (last visited Feb. Project Director. Note. Housing.S. 2001 WL 21107160. 2001 WL 14830457. Will North Carolina's Predatory Home Lending Act Protect Borrowers from the Vulnerability Caused by the Inadequacy of Federal Law?. Securitization's Role in Housing Finance. 27. & Sentinel. Dep't of the Treasury Task Force on Predatory Lending. at 05B.Q. Coalition for Responsible Lending. Curbing Predatory Home Mortgage Lending 40 (June 2000). MBA Official Looks Ahead. 572 n. 9. Stone Soup: Exploring the Boundaries Between Subprime Lending and Predatory Lending. [Fn233]. though in many cases the bond or net worth was much less th an th e amount of one typical home equity loan . [Fn232]. Origination News. of Mortgage Brokers. 2001 . [Fn230]. Id. Rev. at 4. Dec. 2002).A. at C1. What Level of Fiduciary Duty Should Mortgage Brokers Owe Their Borrowers?. Senate Comm. 29. May 25. For a 1997 review of the bond and minimum net worth requirements of mortgage brokers. twenty-nine required paying a fee along with a security bond and/or proof of minimum net worth. at 2.17 (2000) (citing an interview with Susan Lupton. Keest. 11. see David Unseth. Times.S. 503 (2002) Page 82 [Fn228].hud. 1998 WL 2448852. Hitting Home Critics Say California's Lax Regulation of Loan Firms Is Allowing Unscrupulous Businesses to Prey on Unwary Homeowners. 2000. (Nov. 1135 (2001).pdf (last visited Mar. Leland C. [Fn237]. July 27. on Banking. 1241 PLI/Corp 1107. 9. 569. Hawaii Gets Streamlined Licensing. Richard R. [Fn231]. at http://banking. while four provided the heightened level of scrutiny they would give to real estate brokers).S. 1998. in A Primer on Securitization 24 (Leon T. past President. that "Most mortgage brokers who originate subprime loans do so primarily because they enjoy helping people. Dep't of the Treasury Task Force on Predatory Lending.senate.. [Fn235]." Predatory Mortgage Lending: The Problem. [Fn239].--U. 1751-52 (1997) (reporting that thirty-nine states required some licensing to be a mortgage broker. Activists Set to Spar Again in Springfield. Id. Mor tgage Br okers Face New Licensin g Rules. Jodi Nirode. Bus. at 01F. Loan Battle Brews Anew: Subprime Lenders. U. 2001 WL 9360956. Myron Levin. [Fn238]. Oct.Held Up in Due Course: Predatory Lending.hud. July 26.S. six states required some proof of competence to be a mortgage broker. at http:// www. Michele Derus. [Fn240]. The broker whose license is rented is typically elderly or retired. 1999)). and the Holder in Due Course Doctrine. Dep't of Housing and Urban Dev.gov/01_ 07hrg/072701/fendly.A. L.S. however. at D1. 75 Wash. Times. president of the Illinois Mortgage Bankers Ass'n.gov/library/bookshelf18/pressrel/treasrpt. 8. 107th Cong. Neill Fendly asserts. and Urban Affairs. State Agencies Act to Control Fraud by Mortgage Brokers. Nat'l Assoc.C.--U. [Fn236]. 2001). Curbing Predatory Home Mortgage Lending 40 (June 2000). Brendsel. Milwaukee J. N. at http:// www. [Fn234]. Columbus Di spatch . June 10. Impact and Responses: Hearing Before the U.

They Love Lucy It All Began with Slick Hustler s Selli ng Swampla nd to Naive Nor ther ners. The HUD/Treasury Joint report notes: State oversight of brokers. 503 (2002) Page 83 Kendall & Michael J. 182. at BCE1. [Fn253]. at 24-25...hud. [Fn249]. at http://www. moved to new states and began operating there under different names.. 1994). 1996).3d 1462 (3d Cir. 2000 WL 21498650. 991 F. Bankruptcies by these undercapitalized lenders have become epidemic. Dep't of Housing and Urban Dev. Corp. Joint U.J.3d 777. 639 So. Dominick A. 1992). 9. 2000. Bad Loans Made Good. 939-40 (1997). 18.2d 36 (2d Cir. 1995). aff'd. 1130 (S. Jim Waymer. 1995). at http:// www. 1993). and in some cases non-existent. Menowitz v. Dimuzio v. 68 F. 1032 (Fla. Paul). comparing them to the house calls of small town doctors..--U.. 1995).gov/library/bookshelf18/pressrel/treasrpt.S. 1994). 1991. Id. 26. Dep't of Housing and Urban Dev. Brendsel opines that the easy entry into the business helps consumers by fostering competition in service. 94-1559 (DRD). City Investing Co. Rolo v. 1994). Oct. Sarasota Herald-Trib. Oct. Brown. [Fn243]. [Fn245]. Dimuzio.3d 777 (3d Cir. appraisers and contractors is uneven. [Fn254]. Sun-Sentinel (Ft. Joint U. Dist. Curbing Predatory Home Mortgage Lending 81 (June 2000). aff'd. and the Holder in Due Course Doctrine. Nov.2d 1031 (Fla. 68 F. interstate problems might remain. [Fn255]. Supp. Wk. and takes a benign view of the use of telephone and in home tactics of mortgage brokers. Who You Gonna Call?. In re General Dev. at 128. 923. [Fn248].gov/library/bookshelf18/pressrel/treasrpt.pdf (last visited Mar. 1994 WL 872620 (D. Rev. 114 Banking L. at 1B. Fla. When Concerned About Your Concern.S. Aug. 1994). Ct. Dep't of the Treasury Task Force on Predatory Lending. aff'd sub nom Menowitz v. Dist.--U. 639 So.3d at 779. Id. [Fn250]. [Fn242]. 991 F.S. 1991 WL 3941865. Liquidating Trust. 15.Held Up in Due Course: Predatory Lending. 13. Supp. at 02D. Curbing Predatory Home Mortgage Lending 81 (June 2000). Tapken v. . 2002). th inly capitalized brokers. 1999 WL 20275905. Lauderdale Fla. Star Trib.D. 2002). July 30. Securitization. Fishman eds. No. contractors an d lenders who abused consumers. 1993). Dimuzio v. Mar. Civ. vacated on reh'g. 845 F.N.D. 23. James v. 35 Creighton L. 43 F. 1128. Ct.. [Fn244]. 1992). [Fn252]. 68 F. 1993).N. Bus. Brown. Brown. 7. mortgage rates and products. (Minneapolis-St. [Fn247].J. declared bankruptcy. Legal aid attorneys at the regional forums testified about unscrupulous.S. [Fn246]. Nationsbank Trust Co. Dick Youngblood & Bill Urseth. 38 (2d Cir.N. Mazzagetti. 779 (3d Cir. 90-691-CIV-MARCUS.). Even if state enforcement in these areas were heightened.J. 800 F. App. Resolution Trust Corp. Dealing with Mortgage Loan Brokers: Legal and Practical Issues.hud. No. [Fn256]. [Fn251]. Resolution Trust Corp. See infra note 522 and the accompanying text.2d 36.2d 1031.3d 312 (6th Cir.pdf (last visited Mar. App. 194 (D.. But From Those Crooked Roots Rose an Honest to Goodness Great Place to Live. Dep't of the Treasury Task Force on Predatory Lending. 1992 WL 178984 (S. 1999. 1998. 66 F. Area Poised For Growth Boom.Y. Bond Litig. 1998 WL 19884632.

. Mortgage Servicing Takes Center Stage. see James Bryce Clark & Maura B. 43 F. Online. See al so Roach v. [Fn266].pdf (last visited Feb. 1993). 2d at 1034. 1994). Ct. Jan. Peterson. 155 F.J. (last visited Feb. How aggressively a servicer will attempt to collect or foreclose on a loan varies from servicer to servicer. United States v. City Investing Co.freddiemac. also faced with allegations of fraud by GDC. [Fn269]. [Fn273]. 194 (D. Elec. O'Connor. remanding for further evidence regarding the fraud on the borrower.01(C) at 8-3 (Ronald S. Securitizati on: Stru ctured Fin ancing. 2002). 1996. Mortgage Mkts Online. where the court overturned summary judgment for the holder in a foreclosure action. at § 5.pdf (last visited Feb. 1993. Brown. 79 F. [Fn264]. Fed.Held Up in Due Course: Predatory Lending. Id.3d at 1557. depending on the time lines contained in the securitization documents. Dist.5a (1991 & Supp. [Fn272]. 1999. Securitization: Asset-Backed and Mortgage-Backed Securities § 8. 23.htm. 1996). 1994). 255.N. 1155 (Fla. Sec. Resolution Trust Corp. Today.. Id.1998). in which the court. state laws. But Not Lawless. White Collar Criminals On Parade. 1990 WL 7142392. see Rolo v. NationsBank Trust Co. Id.3d 1550. [Fn263]. Brown. 66 F. See Paul T. 1991).3d 644 (3d Cir. General Dev. aff'd.freddiemac. Larry Cordell & Jericho Trianna.. whether th e owner of the mortgage had ever become a holder in due course. Rolo v. Id. For a discussion of this effect in the commercial loan context. 1561. 30. N. App. Judge OKs Plea Bargain in Fla. City Invest ing Co. Tamar Frankel. [Fn271]. Sec. 35 Creighton L. 261 (1998). 1999. 639 So.com/finance/smm/dec99/pdfs/whopays. Borod ed. 1 Tama r Fran kel.. [Fn268]. Cross-Border Securitiz ation: Wi thout Law. at http://www. 2d 1153.com/finance/smm/dec96/html/servicng.. Getting to Know Borrowers Agai n: Who Pays.3d 777 (3d Cir. Nov. at C01. 2000) (citations omitted). 8 Duke J. and local economic conditions. 1998). 707 So. 1990. at http:// www.2d 695 (3d Cir. [Fn260].6. 503 (2002) Page 84 [Fn257]. and an individual servicer may treat different borrowers disparately.). [Fn270].. at http://www. See Chris De Reza. Dec. Wh o Delays and Who Str ays. Allegations Fly in Securities Fraud Case. 182. Dist. 1998). 1993 WL 4521669. June 18. and the Holder in Due Course Doctrine. Financial Asset s Pools. Fin. and Najera v. Mortgag e Mkts Onli ne. James. App. Dec.3d 312 (6th Cir. 2002).. Mortgage Mkts. Ed. [Fn265]. Corp. See Cordell & Trianna. 845 F. Associated Press. Land Sca m Paves Way for $160M in Claims. Dec. 68 F.. C omp. Real Est. Dimuzio v. Sec.freddiemac. 457 PLI/Real 907 (2000). Ct. vacated on reh'g. 1995). 641 So. [Fn261]. 1995). The Record (N. [Fn258]. Rev. 79 F. Securitization. [Fn259]. 16. 949 F.J. Nat'l Mortgage Corp. 8. Liquidating Trust. 2002). 2d 186. Rolo v.3 n. among other things. & Int'l L. For the h omeowners' too ineffectual efforts to recover th eir dama ges. Supp.3d 1462 (3d Cir. 1559 (11th Cir. 16. and Asset -backed Securities § 1. remanded the case to the trial court to determine. Liquidating T rust. the circumstances and payment and communication record of individual borrowers. [Fn262]. Ten Easy Ways to Make a Loan Nonsecuritizable. This point is made in an article from Freddie Mac's online magazine. 187 (Fla. [Fn267].com/finance/smm/dec99/pdfs/whopays.

This conflict of interest is examined in the commercial loan context in Georgette C.J.Held Up in Due Course: Predatory Lending.. and holding them to maturity). at 5." See Robert C. [Fn281]. Odi tah ar gues that separati ng the var ious aspects of the loan process provides greater efficiency by allowing lending institutions to specialize. Selected Issues in Securitization. at § 8. Page 85 [Fn274]. 35 Creighton L. which stands for "Separate Trading of Registered Interest and Principal. 8 Duke J. SF11 ALI-ABA 69. See also Frankel. at least for the securitization of commercial loans. at 259. 1998).04(C) at 8-13.. Even when lenders continue on as servicers. [W]hile banks provide "bundled" services (raising funds. French for "strip. "Tranche" is.65 (noti ng th at ear ly prepayment or late payment of a loan causes one tranche of a securitization to benefit at the expense of another).01(C) at 8-4 (Ronald S. Poindexter. market efficiency should win out over borrower's rights. Hence. [Fn275]. 2001 WL 8192961. 483. Id. 519 (2001). as previously mentioned. Mortgage-backed securities can be sliced up an d repackag ed as collater alized mortgage obliga tions. could work out the troubled loan. Downs & Lenora J. [Fn282]. which could require the lender to take back the loan from the mortgage pool. 50 Emory L. wh ile resolution s of this con flict may disadvantage the marginal borrower who. Tamar Frankel. & Int'l L. Rev. But Not Lawless. sin ce allowing an y modification of the l oan may make t he lender 's origin al repr esentations. originating and servicing loans.. 50 Emory L. . Borod ed. McDaniel. 503 (2002) 2001. [Fn276]. at 560. 261 (1998). Frankel also stresses the efficiency that unbundling creates. Cross-Border Securitiz ation: Wi thout Law. securitization has "unbundled" these functions. enabling separate actors to perform one or more of these functions and linking the actors through a sponsor rather than one super-intermediary. C omp. 65 UMKC L. [Fn277]. Fidelis Oditah. Subordinated Rolling Equity: Analyzing Real Estate Loan Default in the Era of Securitization. if a choice must be made. The jargon of secur itiz ation is hea vy with acronyms and ini tial s. upon wh ich the investors relied. Poindexter." [Fn279]. Rev. 73 (2000). Bankrupts and Other Big Losers. Clearly. Impact of Securitization and Conduit Financing. it virtually ignores the effect of this conflict on the borrower. This "unbundling" and the use of specialized actors can enhance efficiency.J. concentrating on specific parts of the process while leaving the r emainder to other speciali zed in stitution s. Derivative Securities: Governmental Ent ities as End Users. Professor Poindexter points out that. A CMO that di vides the ownership of the mortgage-backed securities into interest-only (IO) and principal-only (PO) pieces is called a STRIP.C. they may well be loath to work with borrowers to avoid a default. [Fn278]. usually through deposits. stating. at 491 n. 65 UMKC L. untrue.. Securitization. See Downs & Fowler. Securitization: Asset-Backed and Mortgage-Backed Securities § 8. in T he Future for the Global Securities Market 83. Providing the opportu nity for immunity would not n ecessarily make a servicer willing to test the limits of that immunity by restructuring a loan for the benefit of a defrauded borrower. While this article extensively examines the potential conflicts of interests between the servicer and the various tranches of a commercial loan pool. & Int'l L. with time and indulgence. the borrowers in securitized transactions are sophisticated parties whom we can assume understand the nuances of the transaction. Comp.. most pooling and servicing agreements establishing the securitization limit the liability of some of the parties steering the loan pool. and the Holder in Due Course Doctrine. 255. 89 (Fidelis Odi tah ed. 491 (1997). K. 1996). whi ch are kn own as CMOs. allowing them to take some actions even though they favor one class of securities holders over another. concluding that. Id. 8 Duke J. Fowler. at 562. Professor Poindexter's analysis is not meant to apply to the much less sophisticated residential borrowers. Rev. (internal footnote omitted). [Fn280]. Id.

allregs.4 (2000). Holdsworth. Securitization. & Int'l L. 2000). 18 Ann. [Fn295]. Supp. Jacobides. at 266. 2002 WL 8158690. if the Wall St reet firms win th ose suits and if the public outcry against predatory lending.allregs. Abstract available at 2000 WL 19064943. 2001. at 102 (1994). [Fn289]. Single Family Seller/Servicer Guide. In addition. For a discussion of this rat ionale for the prohi bition against assigning t he right to collect a debt. avail able at http://www.com (last visited Mar. 35 Creighton L.com (last visited Mar. [Fn296]. See Tamar Frankel. Ronald J. Ronald Mann also asserts that in the course of securitization.1. 16. Searching for Negotiability in Payment and Credit Systems. Va. now at a feverish pitch.. 18 Ann. Jan. these Wall St reet firms may have final ly taken some steps t o ascertain whether t hey are involved with predatory loans. Jan. & Int'l L. 2d ed. 205 (1999). 13 (1915).. Levine & Anthony L. Part IV. Automation and Profit. Banking L. Rev. notes are not transferred by endorsement and delivery. Rev. [Fn285].07(B) at 7-37 (Ronald S. so that the beneficial own er of th e loan pool could be located. Single Family Seller/Servicer Guide. Inc. Frankel states: In securit ization . Frankel. and the Holder in Due Course Doctrine. Mortgaged Lives: a Special Report. Mar. Mortgage Banking. Frankel.04[A][1][b][ii] (Jason H. and notes should be in the name of the servicer or collector to facilitate court proceedings against the borrowers. who would be even more immune to local pressure). 12. Kravitt ed. in another country. 2002). 26 Nat'l Mortgage News. [Fn286]. Rev. 2000. Rev. 44 UCLA L. Id. This action ma y only be short lived. 22. see W. 2002. 31 Law Q. Times. Id. com .P..g. [Fn290]. See Michael G. available at http://www. Mann. at A1. discussed infra notes 611-13 and the accompanying text. For a "servicing r eleased" sale of a note by a predatory lender . available at http://www. [Fn292]. Securitization: The Conflict Between Personal and Market Law (Contract and Property). W. Freddie Mac. [Fn284]. 197. M. Case's Progress a Concern for 'Street'?. at 205. Mortgage Banking Unbundling: Str ucture. [Fn293]. Diana B. and endorsement is very costly. Gray. 951. Fan nie Mae. 15. Freddie Mac. the borrowers may default. at 263. at 2. [Fn291]. at Ch.. The extent to which securitization depersonalizes the lending process is dem onstr ated by Fr ankel's discussion of off-shore SPVs.6(b) (2001). in the sale of mortgage loans) is enormous. [Fn288]. [Fn294]. 970 (1997). in Securitization: Asset-Backed and Mortgage. 2d 718. see Englan d v. See Experience Matters--Subprime Servicing Requires More Than Aggressive Collections. 1999. 1. N. in the wake of wide publicity about predatory lending as well as suits aga inst firms such as Lehman Broth ers regarding their securit izat ion of loa ns origin ated by predator y lending. 503 (2002) Page 86 [Fn283]. at Ch. The Origin s and Early History of Negotiable Instruments. 1. MG Invs. the end orsement r equiremen t raises a serious pra ctical pr oblem when th e number of notes involved (e. May 1. Mortgage Banking. 18. 93 F. 2002). See Frankel. 2001 WL 28402001 for this observation of the decline in servicing by th e originators of loans an d the probable causes for that decline. Borod ed. 2001). 22. 8 Duke J. Vol. Part I. 8 Duke J. See Kyriaki Venetis. 723 (S. Steven B. at 259 (noting that the borrower may be dealing with foreign corporations. 28.Held Up in Due Course: Predatory Lending. Securitization of Financial Assets § 16.D. abates somewhat.allregs. Henriques & Lowell Bergman.Backed Securities § 7. to the extent an SPV has any exact location. 1997) (citations omitted). Banking L. Comp.. 1999 WL 12029545. Currently. Single Family Selling Guide. Rev. Id. however. [Fn287]. Vol.Y. Comp. Protecting t he Tran saction from Bankru ptcy and Insolvency Risks.

19 A. Dist. at 1312 (citation omitt ed). and t aped to the n ote. Haug v. Annotation.C. as the holder removed the staple in order to photocopy the note and allonge separately). 1883). clipp ed. 44. Resolution Corp. 46 (Ga. Ct. 964 S. Ct. Supp. Bush. The court denied that motion. For a discussion of these cases gen erally. Page 87 [Fn297]. 893 F. in which a trustee of a mortgage pool moved for summary judgment based on its alleged status as a holder in due course.1 (1999). v. and Ar ticle 4. at 1195-97.R. 2002). [Fn303]. 1897). Riley. Nationsba nk Trust Co. Memo 01-08: Streamlining of Ginnie Mae's Documentation Requirements (Apr. and Com. The Case of the $19 Million Staple. See also S. SSB v. See Barry Hart Dubn er. 22. Bankers Trust.W. Midfirst Bank. § 3-204(a).S. [Fn305]. Id. and Bishop v. 1994) discussed supra. Watson. However. See also John Krahmer. Constant. [Fn299]. See also James v. [Fn304]. Co. App.C. then th e borrowers' defenses ba sed on the fraud conducted by the originator of the note would be cut off because the trustee would be a holder in due .C. 2001). 1981). 29 Willamette L. Mortgage-Backed Securities: Developments and Trends in the Secondary Mortgage Market 5-25 to -26 (2000). [Fn308]. 56 S. 1304 (D. 1189-91 (E. Lore & Cameron L. 409. 17 F.C.allregs. Supp.D.W. 37. 737 S. 1994). U. App.E.L. at 1194-97... v Artt. Haynes & Co. Chase. Main St.C. Rev. [Fn307]. Rev. Rev. 751 (Ct. 2d 1031 (Fla. 1996). Negotiable Instruments. Pribus v. But see Osgood's Admrs. Bank Deposits and Collections. Supp. it appears that unless the borrowers could somehow show that the trustee had knowledge of the origi nator's fr aud at the time the trustee acquired the mortga ges for the pool. § 3-202(2) (Pre-1990 Version). 53 SMU L. 1900). 1997) (holdin g that a n allon ge was "firmly affixed" to a note where it had been sta pled. 45 (1989). 35 Creighton L.2d 19. at 1197-98. 1080 (Mo. 29 S. 737-38 (2000) (discussing conflicting opinions on whether cases arising under the previous Article 3 should be interpreted under the more flexible rules of the 1990 revision). 173 Cal. Id. based on allegations by the borrowers tha t the tr ustee had pu rchased t he pool of mortgag es with actua l knowledge of the fraudulent sales scheme of the originator of the loans. Bailey. Securitization. See discussion of Ginnie Mae's requirements in Kenneth G. 1996 WL 308285 (4th Cir.C. Secur. 639 So. Va. Bank v. 1996) (per curia m). 22. App. 747. aff'd. Rptr.W. See also Midfirst Bank. 865 F.W. Lewter. 1917) for cases in which the court held that use of an allonge was proper even though th e note had sp ace available for i ndorsemen t. Rev. Bankers Trust (Delaware) v.C.E. v.D. [Fn298]. 1987). Indorsement of Negotiable Instrument by Writing Not on Instrument Itself. [Fn302].3d 1308 (4th Cir.C. 1994). see V.W. 6 Cooley L. 264 (Tex. Commercial Transa ctions.Held Up in Due Course: Predatory Lending.com (last visited Mar. [Fn300]. available at http://www. 87 F.C. then removed and restapled multiple times. 575 (C. 2002). 299 (N. Pharmacy.. [Fn301]. 865 F. 21 (Tex.3d 1297 (1968). [Fn306]. § 3-204. Cowan. 749.G. Supp. 729. Ill. a wholly-owned subsidiary of a company indicted for criminal fraud for its sales of overpriced houses through fraudulent appraisals that misrepresented the value of the homes. Id. Va. U. 1994). and the Holder in Due Course Doctrine. C. 1186. Ginnie Mae. see Crossland Sav. 298.2d 262. 503 (2002) (last visited Mar. cmt. at 1034. 452 (1993) (discussing the new rule). 94 S. 1186 (E. 893 F. New 1990 Uniform Commercial Code: Article 3. 20. "An indorsement on an allonge is valid even though there is sufficient space on the instrument for an indorsement. 236 Beltway Inv. 865 F." U. For ca ses in which the court h eld th at an allon ge could be used only when ther e was in sufficient sp ace on the note for an indor sement. See also Henry J. Supp.

Porter was Sout h Carolina's C onsumer Ad vocate and cur rent ad minist rator of its Department of Consumer Affairs. Joint U. News. 2001).--U. Securitization. 9. Donna Tanoue. Dep't of Housing and Urban Dev. Curbing Predatory Home Mortgage Lending 34 (June 2000). Dep't of the Treasury Task Force on Predatory Lending. Dep't of the Treasury Task Force on Predatory Lending. For a useful. 473 (2000). 462-63 (2000) (statement by Governor Edward M. 105th Cong. 2000. June 16. 2002). Rev. Governor Edward M. 631 (2000). Res.gov/<tilde>aging/hr14ft.federalreserve. 1998). 503 (2002) course. 106th Cong. Rev. 454. Ohio. at http:// www. Me. Treasury Under Secretary. Me. 12-APR S. Mortgage Lending Abuses: Hearing Before the House Comm. Id. 139 (D. Board of Governors of the Federal Reserve System. On Banking and Financial Services. at http:// www.gov/library/bookshelf18/pressrel/treasrpt. Gramlich. 35 Creighton L. 2002). which serves those borrowers either without property or seeking loan amounts too small even for the subpr ime mar ket.S. at 4. [Fn313].Held Up in Due Course: Predatory Lending. Th e Road to Subprime "HEL" Was Paved With Good Congressional Intentions: Usury Deregulation and the Subprime Home Equity Market. Dupuis v.gov/boarddocs/speeches/2001/20010323/default. [Fn322]. 2000). at 2. Member. 51 S. since it will become tradi tional for banks to lend t o subprime borrowers. on Banking and Financial Services. see Cathy Lesser Man sfield. 18 (2001). at http:// www. On Banking and Financial Services. and the Holder in Due Course Doctrine.. Statements to the Congress.hud. Gramlich. Law.htm (last visited Feb. (Mar. L. 1995). May 24. 'Predatory Lending' Raises Default Risk. Supp. Most lenders split . 16. [Fn317]. Joint U.S. Address at Cleveland State University. Mar. Mortgage Lending Abuses: Hearing Before the House Comm. Fed. Philip S. May 24.C. see Lynn Dr ysdale & Kathleen E. [Fn320]. Cleveland. Dupuis. 9. 2002).45 (D.S. 23. At the time of his article. March 1.--U. 879 F. (2000) (statement of Gary Gensler. L. Id. Curbing Predatory Home Mortgage Lending 2-3 (June 2000). 2000 WL 18803344 (quoting Interagency Guidance on Subprime Lending. 106th Cong. (1998) (prepared statement of the Federal Trade Commission. [Fn311].doc" borrowers. [Fn314]. 139.htm (last visited Feb. Porter. 144.S. this definition will become anachr onistic. Bull. [Fn321]. 589. Id. (2000) (statement of Gary Gensler. Home Loan Mortgage Corp. These borrowers with little documentation are labeled "low-doc" or "no. [Fn319]. Keest. [Fn316].hud. Treasury Dep't Under Secretary. [Fn315]. The Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System and Its Challenge to Current Thinking About the Role of Usury Laws in Today's Society.senate. 2000). 23. Dep't of Housing and Urban Dev. 23. Supp. As the subprime market continues to expand and mature and traditional banks increasingly enter the subprime market. Page 88 [Fn312]. 2000).gov/library/bookshelf18/pressrel/treasrpt. Supp.C. [Fn310].pdf (last visited Mar. Home Equity Lending Abuses in the Subprime Mortgage Industry. available at http://www. Rev. For an extensive and penetrating analysis of the fringe banking system. Mortgaging Serv. [Fn309]. 2002). Hearing Before the Senate Special Subcommittee on Aging. before the Comm. at 146. 1995). detailed study of the subprime m arket. [Fn318]. The Two Faces of Truth--in Lending. 879 F.C.pdf (last visited Mar. 879 F. 1999). 51 S. 86 Fed. May 24.

May 24. Mar.htm (last visited June 19. Subprime Lender s Prey on Hard-Luck Consumers. 23 .senate. Feb. and the Holder in Due Course Doctrine.htm (last visited Mar.org/predatory_lending/fdic.--U. 105th Cong. available at 1998 WL 8993224.htm (last visited Feb. 26. Aug. 7.gov/01_07hrg/072701/courson.hud.gov/library/bookshelf18/pressrel/treasrpt.ustreas. Joseph Hu & Jay Elengical. that subprime mortgages' average in terest ra te is between two percent and six percent h igher t han t he prim e rate. Subprime Foreclosures: The Smoking Gun of Predatory Lending? 258-59.gov/press/releases/reports. et al. [Fn331]. [Fn329]. at http://www. 2001). 11. 2002).pdf (last visited Mar. 107th Cong. 1998). on behalf of the Mortgage Bankers Association). 2001. Litan. at 19 (April 2000). Residential MBS Post Solid Year. 105th Cong.html (last visited Mar. Courson. Impact and Responses: Hearing Before the Senate Comm. (1998) (statemen t by Prof.S.S.. at http:// www.house. available at http:// www. (1998) (prepared statement of the Federal Trade Commission. Robert Pollsen. 503 (2002) Page 89 borrowers and credit into categories such as "A. Predatory Mortgage Lending: The Problem. On . May 1. 9.S. [Fn326]. 106th Cong.gov/<tilde>aging/hr14ft.S. 2001. Borrowers with almost un blemished credit records ar e given "A" rating s. ACORN (Association of Community Organizations for Reform Now). 2001). [Fn327]. The Community Reinvestment Act After Financial Modernization: A Baseline Report. Dep't of the Treasury Task Force on Predatory Lending. [Fn330]. [Fn323]. Professor Mansfiel d's fin dings corr elate with t he 1998 esti mate of the subprime industry's own trade group. the National Home Equity Mortgage Association (NHEMA). Gene A. President and CEO." "C.htm (last visited Feb. On Banking and Financial Services." "C-" and "D" even though there is no universal industry standard for these categories. Robert E. at 536-37 . [Fn328]. 2002).. Davies. 2001 WL 12167836. 2002). On Banking. 2002). Bunce. Rev. and a 10% interest ra te is 200 basis points hi gher than an 8% in terest ra te. 2001. See Comments of the National Consumer Law Center and Consumer Federation of America to the FDIC on Predatory Mortgages. See Predatory Lending Practices: Heari ng Before United States Sena te Speci al Comm. 1. Securitization. Man sfield. C. 23. Mortgage Lending Abuses: Hearing Before the House Comm.senate. 51 S. at http:// banking.15%. 21.. Predatory Mortgage Lending: The Problem. (2000) (statement of Gary Gensler. Separate and Unequal: Predatory Lending in America 28 (Nov. 14. See also Paul D. [Fn332]. [Fn324]. Hearing Before the Senate Special Subcommittee on Aging. See Harold L.org/acorn10/predatorylending/plreports/report. See Statement of the National Home Equity Mortgage Association on Home Mortgage Lending Disclosure Reform Before the Housing & Community Development and Financial Institutions & Consumer Credit Subcomms. 2001 WL 11398554." "B. (2001) (testimony of John A. J. 2000). 2002). [Fn325]. at http:// www. A more recent estimate is that subprime mortgages average 1. Un iversi ty of Alabama School of Law). on Aging. 2001). Department of Treasury.nclc. Mortgage Banking. Home Bound: Nasty Surprise Haunts Some Folks' Mortgage: A Prepayment Penalty. 23. Wall St. [Fn333]. Treasury Under Secretary. 16.htm (last visited Mar.. House of Representatives Committee on Banking and Financial Services (September 16. so that 215 basis points equal 2. Home Equity Lending Abuses in the Subprime Mortgage Industry.acorn.html (last visited Feb. at A1.huduser. A basis point is 1/ 100 of 1 percent. Dep't of Housing and Urban Dev. 1998).Held Up in Due Course: Predatory Lending.gov/financialservices/91698nhe. L. 2001 WL-WSJ 2871388. Impact and Responses: Hearing Before the Senate Comm. Philadelphia Daily News.5% to 7% higher than prime mortgages. at http://www. while those curren tly in bankruptcy or foreclosur e are rat ed "F" . et al. Housing and Urban Affairs. Joint U. at http://www. at 4254.org/publications/polleg/hpcproceedings. of the U. available at http://www. Central Pacific Mortgage Co. Marsh. Rev. 35 Creighton L. 2002). Curbing Predatory Home Mortgage Lending 26 (June 2000). U.

gov/library/bookshelf18/pressrel/subprime. Joint U. 24. 2002). L. 23. [Fn339]. Dep't of Housing & Urban Dev. Fair Marketing: Cha llenging Pre-Application Lending Practices. For a market-failure theory of the lending shortfall problem. 787 (1995). 1999) (last visited Feb. 17 Yale J. 197 (2000). An Analysis of GSE Purchasing of Mortgages for African-American Borrowers and their Neighborhoods. Curbing Predatory Home Mortgage Lending 47 (June 2000). Litan.woodstockinst. A Woodstock Institute Report. and the Community Reinvestment Act. L. 2181.html (Nov. Id. Department of Treasury.huduser. Dep't of Housing and Urban Dev.S. as much of the income and assets of potential borrowers in these neighborhoods does not fit into the lenders' typical models for credit standards. Lamber t notes tha t financial in stitution s seekin g to len d in l ow income neighborhoods will have greater information gathering costs. Rev. (2001) (testimony of John A.gov/01_07hrg/072701/courson. 2002). then ap plying a statistical formula to those various numer ical values.C. Rougeau. Courson. 73 Tex.J. Among the factors examined are income. [Fn338]. . see Michael Klausner.pdf (last visited Mar. at http:// www. 24.gov/press/releases/reports. Woodstock Institute. at http://www. 2002). See Robert E. For the ar gumen t that exi sting bank regu lati ons lea d to th e shortfall of lending in urban minority communities. 107th Cong. Lending Discrimination: Economic Theory. 9. creating an individual number representing the creditworthiness of the subject. HUD Paper HF-011. The Persistent Problem of Lending Discrimination: A Law and Economics Analysis. 1565..hud. Rev. found that the prime lenders who serve white and upper-income neighborhoods have not provided credit as widely in lower income and minority neighborhoods. Predatory Lending. at http://www. 2221 (1999). Kenneth G. maki ng any new apprai sals less reliable. Pa.hud. Securitization. The Community Reinvestment Act After Financial Modernization: A Baseline Report. Lambert notes that "a particular segmentation of the market may be permissible if the additional process costs of obtaining the needed information to extend credit to a smaller number of borrowers in a low-income neighborhood exceeds the expected losses to the financial institution for not lending to this creditworthy group. 2002). and age.ustr eas.html (last visited Feb. 15. Dep't of the Treasury Task Force on Predatory Lending.org/twosteps.J. on Reg.gov/library/bookshelf18/pressrel/treasrpt. Gunter. Id. Central Pacific Mortgage Co. Market Failure and Community Investment: A Market-Oriented Alternative to the Community Reinvestment Act. Computerized Credit Scoring's Effect On the Lending Industry. a nd th ere ma y be fewer property appraisals in neighborhoods where banks h ave offered fewer loans. [Fn335]. at 2221-22. 143 U. 237. 35 Creighton L.--U. Two Steps Back: The Dual Mortgage Market. 11. Lambert. on behalf of the Mortgage Bankers Association). Banking Inst.J. 87 Geo. In 1993. and the Holder in Due Course Doctrine. Banks and Inner Cities: Market And Regulatory Obstacles to Development Lending. the subprime refinance rate was eight percent in black neighborhoods and only one percent in white neighborhoods.senate. 87 Geo. at 48. 85 Geo.. L.org/publications/hsgfin/workpapr11." Id. Report Finds Dual Mar ket in Refina nce Loans Subpr ime Lenders Dominat e Lending i n Minor ity Neighborh oods. at 19 (April 2000) (citing recent studies regarding credit administration). 9. 443. Hylton & Vincent D. U. Rev. [Fn337]. Id. assets. debt and repayment history. 4 N. Id. 1561. Swire. (2000). et al. 2002).Held Up in Due Course: Predatory Lending. (April 2000). 503 (2002) Page 90 Banking. For an explanation of di scrim ination theory and t he result ing len ding sh ortfall. Housing and Urban Affairs. and the Undoing of Community Development.S. L. Econometric Evidence. at http:// www. 253-62 (1996).htm (last visited Mar. at http://www. see Peter P. 2002). President and CEO. The Woodstock Institute concludes that this failure by prime lenders to lend in lower income or minority neighborhoods has provided great impetus to subprime lenders to dominate these neighborhoods. Harold Bunce. [Fn340]. Unequal Burden: Income & Racial Disparities in Subprime Lending in America. 444 (2000). htm (last visited Mar .S. [Fn336]. 2000) (last visited Feb. L.html (Dec.. Lambert. Timothy C. at http:// banking.72 (1995) and Keith N. see Keith N Hylton. Credit scoring is a process of assigning numerical values to a variety of factors that indicate the creditworthin ess of a potential borrower. employment. income such as infor mal r ent payment s and assets held outsid e of bank accounts ar e not counted by under writers. [Fn334].

June 16. (1998) (statement of Jim Dough. 9. at 3. J. Discuss Predatory Issues.hud. 106th Cong. Kevin Guerrero. 2000). For example. 7 (2000). 2000 WL . Mark M. Joint U. Ed.gov/library/bookshelf18/pressrel/treasrpt. N. Senate Special Comm.S. J. Fin. What's Their Angle? Consumers must Be Careful When Borrowing from Subprime Lenders. Dep't of Housing and Urban Dev.gov/library/bookshelf18/pressrel/treasrpt. which is 9% of the total mortgage debt outstanding. and the Holder in Due Course Doctrine. 1998). Zandi & Brian Nottage. at http:// www. at http:// www. Trib. Real Est.hud. 2000 WL 8249281..hud. Borrelli. Lenders. [Fn342]. Id. Curbing Predatory Home Mortgage Lending 37 (June 2000).com that there is $400 billion in subprime loans currently outstanding. at http:// www. at A1. of Hackettstown. [Fn352]. 2002). Steven Cocheo. (2000) (testimony of Laura J. 2002). Dep't of the Treasury Task Force on Predatory Lending. [Fn343].gov/library/bookshelf18/pressrel/treasrpt. 1.. [Fn348]. Dep't of Housing and Urban Dev. Chi.--U. Dep't of Housing and Urban Dev. 2001. at 7. Mark M. on Aging. 2001 WL-WSJ. What's Their Angle? Consumers Must Be Careful When Borrowing From Subprime Lenders. 1. Mar.S.gov/os/2000/09/predatorylending.ftc. Reps. The subprime market quadrupled between 1994 and 1999. Will Predatory Lending Shift Fair-Lending Enforcement?. 9. Mortgage Mkts. 2000. Sec.pdf (last visited Mar. 2000 WL 3675686. Mortgage Credit Outlook. July 3. Zandi and Brian Nottage cite an estimate by Economy.Eq uity Lending Market: Prepared Statement Before the Board of Governors of the Federal Reserve System.). [Fn346]. 23. 28 (June 2000) (citation omitted). Feb." according to the Wall Street Journal's report. Trib. Banker. [Fn349]. available at 2000 WL 19304104. 2000..Y. compared to only twenty-one percent of subprime borrowers. Banking J. an estimated thirty-five percent of subprime borrowers were fifty-five years old or older. Dep't of the Treasury Task Force on Predatory Lending. Curbing Predatory Home Mortgage Lending 36 (June 2000). Today. Predatory Lending Practices: Hearing Before the U.pdf (last visited Mar.S. Federal T rade Comm ission. 105th Cong.B. 2000 WL 331599 (citing Moody's Investor Ser vice an d SMR Research Corp. at 56. past President of the National Home Equity Mortgage Association. Mortgage Credit Outlook. 7..Held Up in Due Course: Predatory Lending. States.S. 2000). 2000. 2001. Aug. available at 1998 WL 8993304. [Fn350]. 92 A. Grossman. Kelleher. [Fn351]. Am. Elec. See Home Bound: Nasty Surpri se Haunts Some Folks' Mortgage: A Prepayment Penalty.J.--U. 503 (2002) Page 91 [Fn341]. Id. June 16. See Michael Murray. 16. Joint U. Pr edatory Lendin g Practices in the Home. Lending & Credit Risk Mgmt. estimates that mortgage brokers originate over fifty percent of the subprime loans. Securitization. [Fn354]. then fell about twelve percent during 2000 as "some lenders faced financial problems after making bad loans. at 1. Curbing Predatory Home Mortgage Lending 26.htm (last visited Mar. Securitize or Sink. Chi. at 4. 9. James B Kelleher. Apr. Mortgage Lending Abuses: Hearing Before the House Comm.pdf (last visited Mar. 2000 WL 8249281 (citing Alexander Ross. [Fn345]. 2002). 2002). On Banking and Financial Services. at 1. 35 Creighton L.S. Dep't of the Treasury Task Force on Predatory Lending. citing the tr ade publication Insid e Mortgage Finan ce. N. 2000. Wall St. (Sept. Robert J. Joint U. In their article. Laura J. Working on Guidelines To Cut Predatory Lenders From Securitization Funds. special litigation counsel for Justice Department's Civil Rights Division). 2871388. Borrelli. [Fn347].S. [Fn353]. May 16.--U. May 24.S.A. James B. 2000. at http:// www. [Fn344]. Rev. 2000 WL 3675686.

first. Fidelity Consumer Discount Co.S. Rev. Daily News. Securitization. 51 S. 898 F. as reported by Inside Mortgage Finance. [Fn364].). 7. Daily News. at 40. Banking J. at 502. A. First Franklin Financial Corp. I'll be back in business in a big way. [Fn366]. 1990) as well as other cases cited in Mansfield. at http://www.A.C. 1999 WL 12029538. 2002).. Id. 88. 94 Stat. § 501(a). Id. [Fn360]. Lender Beware. [Fn362]. Feb. June 18. Phil. Curbing Predatory Home Mortgage Lending 30 (June 2000).B. 51 S.S.. 88-1406. Mansfield.S.--U. 161-62 (codified as amended at 12 U. "Predatory Lendin g" Th reatens Subprim e Lenders. Paul D. 503 (2002) 17178326. Department of Justice.C. 589. Page 92 [Fn355]. Rev. Pub. 1989 WL 106695. § 1831d(a) (1994). Rev.usdoj.franklin. See First Franklin. Feb. [Fn365].hud. 6.2d 896 (3d Cir. Deposi tory In stitution s Deregulation and Mon etary Contr ol Act of 1980. 10. based on sample of 15.. [Fn367]. 96-221.html (last visited Mar.gov/library/bookshelf18/pressrel/treasrpt. Cathy Lesser Mansfield. at *16-*17 (3d Cir.Held Up in Due Course: Predatory Lending.C.C. "[I]f the secondary market changes. Phil. Feb. 2001. [Fn356]. Mortgage Banking. L.S. Th e Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System a nd Its Challen ge to Current Thinking About the Role of Usury Laws in Today's Society. Fair Lending Enforcement Program. a mortgage trade publication). May 1.. 51 S. 473 (2000). See Smith v. at http:// www. [Fn368]. Dep't of the Treasury Task Force on Predatory Lending. 1999. Confuse Borrowers. though its chief executive said.S. 51 S. aff'd. at http://www. Cal.com/about/corporate.C. 2000 WL 6213513." Mary Fricker. Dep't of Housing and Urban Dev. About First Franklin Financial Corp. Lynn Drysdale & Kathleen E. Nos. Davies. one mortgage originator dropped from three hundred employees nationwide in late 1998 to just six in 2000. 2001 WL 12167789. L. gov/crt/housing/bll_01. 2001 WL 11595148. Jun. is another example of such rapid growth in the mortgage industry.htm (Jan. 1989). 20 02) (ci ting unpublish ed dra ft 1996 Freddie Mac report.pdf (last visited Mar. L. Lawrence Richter Quinn. Rev. Lender Exits Subprime Loans. Paul D. The Road to Subprime "HEL" Was Paved With Good Congressional In tentions: Usury Deregulation and the Subprime Home Equity Market. 27. and the Holder in Due Course Doctrine. [Fn363]. 12 U. Subprime Lenders Prey on Hard-Luck Consumers. 2001 WL 12167836 (noting a statistic from a poll of the fifty most active subprime lenders. 2001. 132. [Fn359]. 2002). 2001. [Fn357]. 1. 35 Creighton L. § 1735f-7a (1994)). The Press Democrat (Santa Rosa. No. 25. 2000. . at E1. [Fn358]. U.000 subprime mortgages originated by four different financial institutions).C. Keest.1444. [Fn361]. L. Subprime's Thaw. 9. CA. Joint U. at 515-21. 2001) (la st visited Feb. Davies. Some Subprime Brokers Use Questionable Tacti cs. For example. 631 (2000). Rev. of San Jose. at 18. L. Jim Peterson. [Fn369].

Revamping the Phantom Protections for the Vulnerable Elderly: Section 3A1. See id. May 1. eight percent of the homeless clients interviewed were fifty-five years old or older. Homeless Elderly Live Their Lives On the Brink. June 9.htm (last visited Feb.html (last visited Feb. Rev. 79 Or. 6 Elder L. L. 69 Tul. Rev. "Here's a Quarter. Homelessness: Program s and th e People They Serve.J. Rev. at 8.hhs. Sunstein. at 16N. See Martha R Burt.A.1(b). For a defense of includin g non-econom ic losses. 1785 (1995) (defending the inclusion of non-economic losses. Mar. [Fn382]. New Hope for Old Victims. 2001). Don't Cure Predatory Lending By Killing Subprime.gov/progsys/homeless/symposium/13-Preven. Berger. Incommensurability and Valuation in Law. 1999) (last visited Aug. et al. Rev. Bratkiewicz. Sun-Times. 27. L. L. 1999 WL 29019056. 45 S. James R. A. 1999. L. See Harold L. T he Nonpecuniary Cost s of Accidents: Pain-and-suffering Damages in Tort Law. 1991) to prevent m ortgage foreclosur es provided good evidence that homelessness prevention has benefits to the community that go beyond benefits to people whose homelessness is averted. Kentucky. Forrester. 2002. Rev. For a discussion of the humiliation and threatened loss of independence the elderly experience as a result of being victims of crime. Williams. Securitization. Unequal Burden: Income and Racial Disparities in Subprime Lending i n America 8. over twenty years less than the nat ional aver age. Oh io. a t http:// www. at http:// www. James T. . [Fn379]. at 386. Schroeder. Chi. [Fn375]. [Fn372]. see gener ally Steven P. 2001. See Jeanne L.D. Rethinking the Prevention of Homelessness. 35 Creighton L. in any economic analysis of the effects of tortious beha vior. Call Someone Who Cares".Held Up in Due Course: Predatory Lending. Assistant Secretary for Housing at HUD). and Colorado (Sch wartz et al. such as pai n an d suffering. Peterson. and the Holder in Due Course Doctrine.B. Buff. Banking J. up 20% from the year before. Mortgaging the American Dream: A Critical Evaluation of the Federal Government's Promotion of Home Equity Financing. For a discussion of incommensurability.. 19..org/publications/polleg/hpcproceedings. 2001 WL 11595211. [Fn373]. 26. likely showing the effects of efforts to prevent h omelessness among elderly. 779 (1994). [Fn374]. Trent M. et al.huduser .. Dec. at http://aspe. 244-45 (2000) (discussing the "Madelaine" effect and its economic implications). [Fn377]. see Cass R. L. 92 Mich. 69 Tul. 2002). [Fn376]. Subprime Foreclosures: The Smoking Gun of Predatory Lending? 258-59. Note. Cr oley & Jon D. 23. see Jeffrey L."). Who Is Answering the Elderly's Call for Protection from Telemarketing Fraud?. United States Dep't of Housing & Urban Development.org/publications/ fairhsg/un equal. [Fn381]. [Fn371]. See Sandra Guthans. According t o a study by the Federal In teragen cy Council on the Homeless. in any economic analysis of the effects of tortuous behavior).html (April 2000) (la st visited Aug. 2002 WL 7421447. Hanson.. Texas. Bunce. 373. See Fred O. at http://www. at B4. 49. [Fn383]. [Fn378]. Murch. Rationality in Law and Economics Scholarship. Julia Patterson Forrester. 590 (2000). 2001). 16. 108 Harv. 2000. 147. Rev. 503 (2002) Page 93 [Fn370]. such as pain and suffering. News. 5. 55-56 (1998). 2000 WL 6681282 (quoting William Apgar. 2002) ("The HOPE program in Penn sylvania. Marybeth Shinn & Jim Baumohl. Lenders started foreclosures on 36 out of 1000 loans in the fourth quarter of 2001. New Orleans Times-Picayune. [Fn380].huduser. 386 (1994). Subprime Lending Produces Dangerous Side Effects. but forty-five percent of the non-homeless that used homeless services were elderly. Avoid Foreclosure. L. Rev. 586. One study concluded that th e life expectancy of the homeless is only fifty-one years.org/publications/homeless/homelessness/ (Dec.huduser. at 3C.

In re Ralls. Impact. and (5) where equitable to do so. [Fn394]. See Transcript of the Federal Reserve Board Morning Session of Public Hearing on Home Equity Lending (Aug. at 45. Housing.S. § 226.J. 2001) (testimony of David Berenbaum of the Nat'l Community Reinvestment Coalition. Rev.S. 2002). § 1639(a)(2)(B) (2000). Z. 230 B. [Fn400]. § 1639(a)(1) (2000).F.S. Joint U. elimination of the debtor's entire obligation to the creditor and (6) recovery of all payments made. Curbing Predatory Home Mortgage Lending 25 (June 2000). Dep't of Housing and Urban Dev. Reg.htm (last visited Feb.pdf (last visited Mar. § 1601. 15 U. 26.gov/Events/PublicHearing s/20000816/20000816. See Truth in Lendin g (Regulation Z). 70 Yale L. see Guido Calabresi. Cass R.C.C.S. at http://banking. Dep't of Housing and Urban Dev. Predatory Mortgage Lending: The Problem. E. 9.S. Some Thoughts on Risk Distribution and the Law of Torts. 503 (2002) [Fn384].F. On Banking. July 27. 1471. 12 C.D. 12 C.R. [Fn390]. § 1602(b) (2000). (3) a penalty measu red by at least r ecoupment against t he remainin g unsecured claim on a ccount of the orig inal T ILA disclosure violations.--U. at http:// www. Dep't of the Treasury Task Force on Predatory Lending.R. Securitization. 2001). [Fn399]. 108 Stat. E. and (7) recovery of reasonable .S. (2) statutory damages for failing to properly respond to the rescission demand. §§ 1602(aa)(1). [Fn395].Held Up in Due Course: Predatory Lending. L. 15 U. at h ttp:// feder alreserve. 2002). Dep't of the Treasury Task Force on Predatory Lending. at http:// www.senate.htm (last visited Feb. 65 Fed.S. See sup ra n ote 188-89 an d accompanying text for the for eclosur e process and a discussion of how a borrower normally loses any equity in the house when it is foreclosed. Sun-Times. [Fn398]. 1999). 9. (3) (2000).C. Page 94 [Fn387]. § 1602(f) (2000). Curbing Predatory Home Mortgage Lending 49 (June 2000). 2002) (reporting the testimony of Dan Immergluck of the Woodstock Institute). 15 U.C. at 49. Chi. and Urban Affairs. at 16N. Joint U. 2000 WL 6681282. [Fn388]. Riegle Community Development and Regulatory Improvement Act. 35 Creighton L. [Fn397]. 14. 103-325. and Responses: Hearing Before the Senate Comm. (July 27.S. et seq. 2002). [Fn396].S. Reg. L. 81. 1541-42 (1998).hud. Pa. A Behavioral Approach to Law and Economics. Rev. 499. 2000). [Fn392]. 514 (1961). 2000.gov/01_ 07hrg/072701/brenbaum. [Fn389]. Pub. 239 B.pdf (last visited Mar. 2190-98 (1994) (enacted as a part of the federal Truth in Lending Act (TILA). For the argument that people purchase more of a good when the true cost is not reflected in the price. 508. 15 U. 107th Cong.gov/library/bookshelf18/pressrel/treasrpt. See In re Murray. 26. 16.D. 15 U.C.R. Berger.32). 514.438 (Dec. 521-23 (Bankr. § 226). 728 (Bankr. (4) elimination of all finance charges. June 9.C.R. [Fn391]. Pa. 50 Stan. [Fn385]. Christine Jolls. Id. and the Holder in Due Course Doctrine. 2000) (proposing revi sions to FRB Regulation Z. 1999) (noti ng th at th e remedies are "(1) termination of the creditor's security interest. [Fn393].--U.gov/library/bookshelf18/pressrel/treasrpt. No. 15 U.S. Sunstein & Richard Thaler. § 151-58. [Fn386].hud.

1125 (2001). § 1639(d) (2000). Kathleen E. 1993 WL 3013956 (reporting the statement of Lawrence B. 2d 965. Richmond Times-Dispatch. 15 U. Move Afoot to Halt Abusive Lending. Fed.S. Big Business Targets Low-income Districts. 15 U. See Sandra Fleishman.. 12 C.D. Dec. § 1639(c) (2000). 503 (2002) attorneys' fees and costs by the successful debtor's counsel"). (1994) (testimony of Joseph Falk. 53 F. Keest. [Fn416].C. 733 (Bankr. Securitization. [Fn419]. In re Murray. Page 95 [Fn414]. Bull. § 1640(a)(4) (2000). 15 U. Fin. Fed Favors Tougher Loan Rules. 1999). Id. 15 U. Nat'l Ass'n of Mortgage Brokers. 22.C. [Fn403].C. E. 1993.hud. § 1639(f) (2000). 15 U. § 226. 2000. [Fn411]. revealed how near its fees were to the fee trigger when it estimated that ninety percent of its loans would be covered by HOEPA if the fee trigger would include the cost of single premium credit insurance. [Fn413].C. §§ 1602(u). [Fn406]. Lindsay)..R.S.S.S.gov/library/bookshelf18/pressrel/treasrpt. Subcomm. § 1639(e) (2000)." sa id Gramli ch. 2000 WL 5049721. and the Holder in Due Course Doctrine. on the board of governors of the Federal Reserve. Rev. Joint U. at E01.S. Pa. 2000. § 1641(d)(1) (2000). 9. at http:// www. 2000 WL 29921414. 315 3 Before the Consumer Credit a nd Ins.. Dep't of Housing and Urban Dev. [Fn409]. One lender.D. [Fn415]. at A1. § 1639(h) (2000).S. Post. Carol Hazard . Wash.S. Mich. [Fn405].S. [Fn404].F. Supp. 1639(j) (2000). Vandenbroeck v.C. 728. 15 U. 967-68 (W. 15 U.pdf (last visited Mar. July 1. [Fn407]. 1635( f). §§ 1602(u). 9.C. Dep't of the Treasury Task Force on Predatory Lending.C. Abuses in SUBPRIME Lending Are Targeted. § 1641(d)(4) (2000). 239 B. Statements to the Congress. [Fn412].C. 2002). "While most an alysts consider HOEPA to have been effective. 15 U. 1993 WL 3013956.Held Up in Due Course: Predatory Lending.S.R. 15 U.--U. [Fn410]. [Fn417]. Stone Soup: Exploring the Boundaries Between Subprime Lending and Predatory Lending. See Home Loans and Low Income Families: Hearing on H. at 684.R. for example. Predatory Loans Often Set up Borrowers for Failure an d Can Cost Them Their Biggest Investment: Their Homes.S. Res. [Fn402].S. Curbing Predatory Home Mortgage Lending 85 (June 2000). 1639(j) (2000).C. 14. 15 U. Mar.32(e)(3).S. 1994). ContiMortgage Corp. Oct. 1241 PLI/Corp 1107. [Fn401]. 1999). 103d Cong. of the House Banking. . and Urban Affairs Comm.C. we hear report s of lenders skating just below the HOEPA r equir ement s and still engaging in egregious pr actices. [Fn418]. 35 Creighton L. [Fn408].

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[Fn420]. Joint U.S. Dep't of Housing and Urban Dev.--U.S. Dep't of the Treasury Task Force on Predatory Lending, Curbing Predatory Home Mortgage Lending 85, 89 (June 2000), at http:// www.hud.gov/library/booksh elf18/pressrel/treasrpt.pdf (l ast visited Mar. 9, 200 2). For a defin ition and descri ption of yield spread prem iums, as well as a discussion of whether th ey violate a mortga ge broker's fiduciary duty, see Robert M. Jaworski, Overages: To Pay or Not to Pay, That Is the Question, 113 Banking L.J. 909, 910-12 (1996). [Fn421]. Kathleen E. Keest, Timothy P. Meredith & Elizabeth C. Yen, 1997 Truth in Lendin g Developments, 53 Bus. Law. 971, 981 (1998). [Fn422]. Newton v. United Cos. Financial Corp., 24 F. Supp. 2d 444, 457 (E.D. Pa. 1998). [Fn423]. 66 Fed. Reg. 65604-65607 (Dec. 20, 2001). [Fn424]. 66 Fed. Reg. 65606, 65608-65610 (Dec. 20, 2001). [Fn425]. 66 Fed. Reg. 65612-65613 (Dec. 20, 2001). [Fn426]. This point is made in Keest, 1241 PLI/Corp at 1139. [Fn427]. Jean Constantine-Davis, HOEPING for Bett er Days: the Home Ownership an d Equity Prot ection Act of 1994 (HOEPA), 1114 PLI/Corp 243, 252 (1999) (citing Newton v. United Lending Co., 24 F. Supp. 2d 444 (E.D. Pa. 1998)). [Fn428]. In re Jackson, 245 B.R. 23, 32 (Bankr. E.D. Pa. 2000). [Fn429]. This discussion of the complexity of HOEPA and the detrimental effect of that complexity to the enforcement of HOEPA was sugg ested to me, along with examples of th at complexity, by Kath leen Keest, t o whom I am grateful. [Fn430]. 15 U.S.C. § 1602(aa)(4) (2001). [Fn431]. 15 U.S.C. § 1639(c) (2001). [Fn432]. How unlikely it is that a borrower will find a n attorn ey who understands HOEPA can be seen in th e case Bostic v. Am. Gen. Fin., Inc., 87 F. Supp. 2d 611 (S.D. W. Va. 2000), in which the court accepted as reasonable the st atement of bor rower' s attorney that no oth er attorn ey in th e state of West Virgin ia suffi cient ly understood TILA (of which HOEPA is a complicated part) and the Equal Credit Opportunity Act (ECOA) to aid him in litigating the case, necessitating that he bring in counsel from out of state. The attorney stated that the out of state counsel's role was key in dealing [with] th e Truth in Lending as well as the E COA claim. I know of no one else in West Virginia who has any substantial knowledge of Truth in Lending and ECOA claims, an d it was essential to go out-of-state to get this kind of experience. Id. [Fn433]. An exam ple of how difficult HOEPA is for judges to apply can be found in the case In re Barber, 266 B.R. 309 (Bankr. E.D. Pa. 2001). There, the court wrestled with the basic question of whether HOEPA abrogates the holder in due course doctrine, stating all too tentatively, At least one court has held that Section 1641(d) "eliminates HDC [holder in due course] defenses as to all claims asserted by the consumer under TILA or other laws, unless the assignee proves, by a preponderance of the evidence, that it could not determine that the loan was a HOEPA loan." Id. (quoting In re Murray, 239 B.R. 728, 733 (Bankr. E.D. Pa. 1999)). [Fn434]. 15 U.S.C. § 1641(d)(1) (2000).

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[Fn435]. 15 U.S.C. § 1641(d)(4) (2000). [Fn436]. Tri-Star Mortgage/Polo Financial cheated numerous homeowners and other lenders for years before its fraud was discovered. See Myron Levin, California Woodland Hills Broker Gets 3-Year Term in Mortgage Scam, L.A. Times, July 19, 2000, at C2, 2000 WL 2261701; Jesse Hiestand, Man Gets 3 Years in Fraud Case, L.A. Daily News, June 23, 2000, at N17, 2000 WL 31038984; Myron Levin, California Valley Mortgage Brokers Face 11 Charges, L.A. Times, Apr. 13, 2000, at C2, 2000 WL 2230456. [Fn437]. Ben Sullivan, Home Loan Scandal; Valley Seniors Say They Were Cheated, L.A. Daily News, May 10, 1998, at N1, 1998 WL 3858449. [Fn438]. Sullivan, L.A. Daily News, May 10, 1998, at N1, 1998 WL 3858449. [Fn439]. Id. [Fn440]. Michael Youngblood, real estate analyst for Banc of America Securities, explained how lenders can conceal that a loan is covered by HOEPA: "And if they're lying to the company that buys their loans, and saying there's been no more than five points, or no more than ten points associated with a given loan, when in reality the total number of points is much higher, it's very difficult to uncover fraud until it's too late." Michael Gregory, If Trusts Were To Break Wide Open: The Shake-Up in Subprime Lending and Its Impact on ABS, Asset Sales Rep., June 26, 2000, 2000 WL 3953601. [Fn441]. Arguably, HOEPA deters even the dishonest predatory lender once the buyers of mortgage discover this fraud. However, as dem onstrat ed by the examples of fraud described her ein, th e damage th at a dish onest lender can do before its fraud is discovered is extreme. [Fn442]. E. Scott Reckard, California Mortgage Lender Hit With State Lawsuit, L.A. Times, June 13, 2001, at C2, 2001 WL 2495071. Because First Alliance is such a central figure in the ineffectiveness of efforts to deal with predator y lending, any detailed discussion of this issue must a ccount for First Allian ce's stunn ing success an d even mor e sudden ba nkruptcy. [Fn443]. Diana B. Henriques & Lowell Bergman, Fast Talk and Home Equi ty Wall Street Loves Fir st Allian ce, Despite Lender's Legal Problems, Plain Dealer (Clev.), Mar. 18, 2000, at 1C, 2000 WL 5138774. [Fn444]. Elderly Couple Win $1 Million from Mortgage Company, Orange County (Cal.) Reg., Oct. 16, 1987, at B06, 1987 WL 3876949. [Fn445]. State Files Suit/Loan Firm Accused of Anti-Black Bias, S.F. Chron., Aug. 12, 1988, at A6, 1988 WL 6116729. [Fn446]. Al Delugach, State Bans 'Misleading' Ads by First Alliance Mortgage, L.A. Times, Aug. 19, 1988, at 2, 1988 WL 2221809. [Fn447]. Al Delugach, Case Against First Alliance Stalled by Judge, L.A. Times, Aug. 16, 1988, at 2, 1988 WL 2222758. [Fn448]. Dan Weikel, Mortgage Company Spared From Receivership, Orange County (Cal.) Reg., Oct. 7, 1988, at A03, 1988 WL 4453689. The judge also rejected the state's ban on First Alliance's advertising. Id. [Fn449]. Tony Cox, First Alliance Settles State's Redlining Suit, Oran ge County (Cal.) Bus. J., Oct. 2, 1989, at 1, 1989 WL 2632567.

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[Fn450]. Hedging Concepts, Inc. v. First Alliance Mortgage Co., 49 Cal. Rptr. 2d 191, 194 (Ct. App. 1996). [Fn451]. Id.; Activity Subsides, But Privates Keep Pace, Asset Sales Rep., Mar. 23, 1992, at 1, 1992 WL 5270089. [Fn452]. New Issue Scorecard, Asset Sales Rep., Aug. 30, 1993, at 6, 1993 WL 5862330; First Alliance Offers First Public Deal, Mortgage-Backed Sec. Letter, Aug. 23, 1993, 1993 WL 2785929. [Fn453]. Low-Grade ARMs Attracting Lenders, Mortgage Marketplace, Nov. 22, 1993, at 10, 1993 WL 6757561. See also Edward Kukosky, Q & A: Self- Securitization Eases A Switch to Adjustables, Am. Banker, Nov. 24, 1993, at 10, 1993 WL 5816766. [Fn454]. Ana stasi a Hendrix, Loan Fi rm Bilked Elderly, Suits Say. Ba y Area Pl aintiffs Accuse Fir st All iance of Deception, S.F. Exam'r, June 9, 1997, at A1, 1997 WL 4340776. See also Diana B. Henriques & Lowell Bergman, Mortgaged Lives: a Special Report, N.Y. Times, Mar. 15, 2000, at A1, Abstract available at 2000 WL 19064943. [Fn455]. Tom Kelly, Before Signing, Understand Rates, Loan Fees, Seattle Times, July 23, 1995, at G1, 1995 WL 5033739. [Fn456]. Jonathan Lansner , Stock Sale May Get $55 Million For Firm, Orange County (Cal.) Reg., May 15, 1996, at C05, 1996 WL 7027645. [Fn457]. Marla Dickerson, Two O.C. Companies Test Testy Market Stocks, L.A. Times, July 27, 1996, at D1, 1996 WL 11252834. [Fn458]. Jonathan Lansner , There Are Reasons These People Make So Much, Orange County (Cal.) Reg., May 27, 1996, at C01, 1997 WL 7425276. The New York Times reported that the founders received $135 million in the course of this transaction. Henriques & Bergman, N.Y. Times, Mar. 15, 2000, at A1, Abstract available at 2000 WL 19064943. [Fn459]. First Alliance Opens MA Branch Office, Origination News, Apr. 1, 1997, at 25, 1997 WL 24626585. [Fn460]. Hendrix, S.F. Exam'r, June 9, 1997, at A1, 1997 WL 4340776. [Fn461]. Henriques & Bergman, N.Y. Times, Mar. 15, 2000, at A1, Abstract available at 2000 WL 19064943. [Fn462]. Alex Rodriquez & Bill Rumbler, Loan Officers Told To Mislead, Ex- Worker Says, Chi. Sun-Times, Apr. 4, 1999, at 15, 1999 WL 6532908. [Fn463]. Id. [Fn464]. Norma Garcia, The Hard Sell: Combating Home Equity Lending Fraud in California, 32-33 (Consumers Union of the US, Inc., West Coast Regional Office, July, 1998), available at http://www.consumer.org/finance/hsreportwc898.htm (last visited Mar. 6, 2002). [Fn465]. Id. at 11. [Fn466]. 466. Diana B. Henriques & Lowell Bergman, Fast Ta lk and Home Equity Wall Street Loves First Alliance, Despite Lender's Legal Problems, Plain Dealer (Clev.), Mar. 18, 2000, at 1C, 2000 WL 5138774. [Fn467]. Id. [Fn468]. Kathryn Tong, Crackdown on Subprime Lenders State, Activists Ta ke Aim at Abusive Pra ctices, Boston Globe, Aug. 13, 2000, at H1, 2000 WL 3338524 (citing Pam Kogut, a Massachusetts assistant attorney general).

[Fn480]. Ariz. Myron Levin. 10. 30. 1997. at 1C. Even Of Legal Deals. See Alan S. Kaplinsky & Mark J. Mortgaged Lives: a Special Report.F. Diana B. S. No. 2000). 2000. 1998 WL 2449906. Mar.. at A1. Quantifying the Economic Cost of Predatory Lending.. S. May 7. No. at D1. Bright v. May 5. 1998 WL 2425183. Fir st Allian ce Mortg age. Oct. CO. CV76 6996 (Cal. Salt Lake Trib. Banker. 28. [Fn471]. For a discussion of the benefits to a consumer lender generally of arbitration agreements. Anatomy of An Arbitration Clause: Drafting and Implementation Issues Which Should Be Considered By a Consumer Lender. 1997 WL 2232262. Anatomy of an Arbitration C lause: Dr afting and Implementation Issues Which Should Be Con sidered by a . Plain Dealer (Clev. Loan Fi rm Bilked Elderly.F. 20. Ct. 1997 WL 4342269. Id.). Dec. N. [Fn474]. 1998. at D5. at A5. Ut ah. 1998 WL 2609390. 1998. July 25. 2000). Bagley v. Exam'r. Feb. A Report from the Coalition for Responsible Lending 5. . 1997 WL 24626707.or g (revised Oct. AARP Joins Suit Against First Alliance Mortgage. 1998 WL 4882921. No. First All iance Mortgage Co. First Allia nce Mor tgage Co.. at D1. 1998) (holding an arbitration clause binding despite the lender's failure to explain it. [Fn476].. 1997. L. City and County of Denver. Kaplinsky & Mark J. Orange County (Cal. at A1. Suits Allege Loan Fraud By Mortgage Company First Alliance. 28.F. at A1. [Fn478]. McAndrew v. 1997. at D2. 1. Pa gter v. Daily Star.g. e. Exam'r. See Eric Stein. First Alliance Mortgage Co. 18. at 6B. at 6B.Held Up in Due Course: Predatory Lending. Myron Levin. 1997. 25.A.. Customers Say Mortgage Firm Took Them For Up To $15. S. 1997 WL 16299909. Levin. 1998. Ill. Mar. [Fn479]. as well as the drafting issues involved and a discussion of the resulting litigation. at 69. 228 (2001) (citing several First Alliance cases involving arbitration clauses. 1997. 1997 WL 4348474. Minorities Beware. Dec. 1998.A. An estima ted twenty percent of its loans were made to borrowers with "A" credit rating. 1997. Dec. statin g "Loans generate a lot of pap er. 1999). 1997 WL 16299909. Exam'r. 1997) an d Durney v. and no law of which I a m aware requires th e papers to be oral ly explicated to the sign ers"). May 7. 28.F. Fast Talk and Home Equi ty Wall Street Loves Fir st Allian ce. 98 C 3848 (N. 1997 WL 4340776. 2000 WL 5138774. 2000. at A5. 35 Creighton L. Customers Say Mortgage Firm Took Them For Up To $15.Y. Anastasia Hendrix. at 1.. Dec. Am. 2001)).. Minorities Told To Be On Guard.. AARP Joins Lawsuit Charging Fraud By Subprime Lender Against Seniors. 1997. First Alliance Corp. Fir st Allian ce Mortgage Co. Despite Lender's Legal Problems. First Alliance's Mix Sets it Apart from Other Lenders. at K01. Ill. Orange County Earnings. L. 1:99-CV-00206 (N. [Fn473]. [Fn477]. Daily Star. Ana stasi a Hendrix. [Fn470]. see Alan S. July 29. No. Ba y Area Pl aintiffs Accuse Fir st All iance of Deception.A. Shawn Foster. Feb. 2:99. [Fn472]. Nov. Times. Oct. 99CV3762 (Dist. 15. Exam'r. Assista nt Attor ney General of Massachusetts at a meeting between consumer advocates and the Federal Reserve Board of Governors (April 12. June 9. Ariz. Ct. See. L. First Alliance. 1997. 1997 WL 15239828. Super. Heather Timmons. Henriques & Lowell Berg man. Prices $85 MM ABS. Burned By Home Loans Borrowers Allege They Were Duped Into Deals That Were Deceiving. App. 1997. Suits Say.CV-578B (D. Times. Times.responsiblelen ding. No..000. 223-24. 1997 WL 4342269. H018267 (Cal. Nationscapital Mortgage Accused.. Case No. Levin. at http:/ /www. Times. S. 27. and the Holder in Due Course Doctrine. 503 (2002) Page 99 [Fn469].000. Henriques & Lowell Bergman. 11. Rev. 2001) (citing r emarks by Pamela Kogut. Diana B. 1 2. July 7. SF81 ALI-ABA 215. Hendrix. Abstract available at 2000 WL 19064943. Jan. Securitization. 1999)).D. July 7. including Jones v.D.) Reg. Origination News. [Fn475]. See also Anastasia Hendrix.

Paul). Frey. 35 Creighton L. First Allia nce Settles Consumer Fraud Complaint Agreement. FACO Completes $120 Million Deal. Rev. 50 DePaul L. Times. Mar. Sept. 1998. at 1223 ("Thus. 2000 J. Smith. at C3. Rev. J. Securitization. [Fn495]. Star Trib. 2000.J. (Minneapolis-St. Neal Gendler. 1998. 1999. 629-57 (1988). Page 100 [Fn481]. and the Holder in Due Course Doctrine.. 1998 WL 6377523. 1999 WL 16553533. 28. 1999. see generally Thurston K. Oct. Times. 427-29 (2000). 1999 WL 32643275. Disp. 15. The high ratings for the securitizations of First Alliance's loan pools was aided by the credit enhancement provided by one of the nation's large financial insurance companies. 50 DePaul L. at 051. Industry Briefs. N. [Fn487]. E. See also Smith. 1999 WL 26178206. [Fn491].C. 10-APR Bus. at 1229-30 and Martin A. Rev. 35 UCLA L. Mandator y Arbitr ation Clauses in Consumer Contr acts: Consumer Protect ion and the Circumvention of the Judicial System. Rev. Discovery in Arbitration? Well. Arbitration and Collateral Estoppel: Using Preclusion to Shape Procedural Choices. 1998 WL 6378591. [Fn488]. at 03B. 1191. Alleging Exorbitant Fees. 1998. [Fn485]. 278-81 (1997). L. 503 (2002) Consumer Lender. Rep. Jan Norman. Comment. Neal Gendler.Held Up in Due Course: Predatory Lending. Paul). NJ Suit Accuses Mortgage Lender Of Fraud. Mortgaged Lives: a Special Report. [Fn484]. 1230 (2001). [Fn492].A. Dec. 29. [Fn493]. (Minneapolis-St. 63 Tul. Diana B. Arbitration and its Collateral Estoppel Effect on Third Parties.Y. Dec.A. Mar. Res Judicata and Collateral Estoppel in Labor Arbitration. Res Judicata and Collateral Estoppel Effects of Commercial Arbitration. and G. Mar. 1998 WL 18767767. 727. at 02B. at 6. William Kleinknecht. Strategist 1 (1997). at 1. Nat'l Mortgage News. at A1. [Fn494]. [Fn486]. [Fn482]. June 28. Henriques & Lowell Bergman. it can continue engaging in harmful or unlawful practices without fearing lawsuits or bad publicity. Today 22 (2001). 50 DePaul L. 623. Heinsz. [Fn490]. First Alliance Says It Faces Federal Inquiry Into Lending Financial Services. Scott Reckard. [Fn489]. Hiroshi Motomura. 1998. 31-32 (1988). 15. Times. at A1. N. Richard Shell. 18. Jan 24. How Arbitration Clauses Can Help Avoid Class Action Damages. [Fn496]. See Smith. Maintaining Their Optimism First Alliance Mortgage's Leaders Say Their Company Will . SF81 ALI-ABA 215 (2001).Y. Cromwell. Henriques & Bergman. Note. 1999. L. 14 Computer L. L. Carnathan. Dec. Bank Adver. See also. State Sues Home Lender. News. L. Rev.T Westermeir. 1998 WL 9577688. Shelly Smith."). at 1229. 2000. Star Trib. without precedent. 1998. 425. Dec. 2. Rev. Mor tgage Firm's Legal Pr oblems Add Up: Minnesota. Times. Grieve it Again: of Stare Decisis.J. Rev. First Alliance Plans New Site. Fannie Mae Reopens $2 Billion Five-Year Benchmark Note. Credit Risk Mgmt. See generally. Nat'l Mortgage News. See generally. 275. Other States Targetin g First Alliance. For discussions of the interplay between arbitration and collateral estoppel and res judicata.). 50 DePaul L. 9. Rev. Does ADR Offer Second Class Justice?. 28. It Depends. 22. at C2. Abstract available at 2000 WL 19064943. 29. L. [Fn483]. 36 Tulsa L. 1998 WL 18881573. out of court dispute arbitration is attractive to large corporations because. Star-Ledger (Newark N. Edmund Sanders. Abstract available at 2000 WL 19064943. Timothy J. Sean T. 735 (2001). 38 B. 1998 WL 33865850. Resol. 1998.

31. L. Orange County (Cal. Markets First Alliance Will Refund $60 Million Financing. See James B.Y. Abstract available at 2000 WL 19065654.A.A. 37 Bankr. 264 B. 2001). Cal. at C2. 634. 2000.D. N.. 2000. James B. 2001 WL 16513664. Plain Dealer (Clev. The New York Times reported: "Financial records provided to investors by First Alliance on March 14 showed no signs of financial distress. [Fn497]. at A1. 2001). 2000 WL 2248330. at C1. Ca lifornia Bankruptcy Judge Bars Retir ement Gr oup from Suing Irvine. 2002. Inv. [Fn508]. In re First Alliance Mortgage Co. 18. Page 101 [Fn498]. Henriques. Diana B. 15. 2000. In re First Alliance Mortgage Co. Mar. 2000. 264 B. Mortgage Lender Files Chapter 11 First Alliance Corp.D. Dealers' Dig. Cal. 428 (C. 2000. Judg e Stalls Suits Against Foun der of First Al liance Ba nkruptcy. [Fn510]. See In re First Alliance Mortgage Co.Y.Held Up in Due Course: Predatory Lending. Mar.). 2000 WL 4667107. Times..).-Based Lender. First Alliance Mortgage Firm Seeks Bankruptcy Protection. Securitization. Kelleher. 634 (C. at A11. First Alliance's attorney reportedly noted that First Alliance spent $6 million defending itself durin g the previous year. E.R. 7. 2000 WL 4666934 and Michael Gregory. Increasi ng Involvemen t of Regulatory Agencies and Public Officials in Consumer Issues 1242 PLI/Corp 581 (2001). Orange County (Cal. at K01. Times. (Spokane Wash. at A1. Despite Lender's Legal Problems. Times. 269 B. and the Holder in Due Course Doctrine.. N. 2000. [Fn509]. 2002 WL 2462793. including more tha n $15 mi llion in cash. [Fn499]. Cal. 25." See Diana B. Under Fire. Ct. Dealers' Dig . 22. at C1. Henriques & Bergman. Henriques. In 2000. 2000 WL 6758503. Mar. Calif. Inv. Faces Many Lawsuits. Times. Scott Reckard. Lehman Brothers i s Wall Str eet's fourth-largest brokerage house. Rev. L. Class Action Proofs Disallowed for Some in First Alliance Mortgage Case. 2000. 634 (C. 2001). L. N. Mar. [Fn501]. 2002 WL 5442455 and E. Mar. June 26. Banks Win in First Alliance Pact. Mayer. at 7 (March 21. [Fn513]. 2000 WL 13955318. 20. [Fn504]. Dec.D.. See Henriques & Bergman. 2002. Bert Caldwell. [Fn507]. 2000 WL 5138774.) Reg.R.R. Diana B. [Fn512]. 2001). 2000.D. at A1. an d liabilities of just $33 mil lion. . See Edmund San der s. May 8. (LRP) No.. Scott Reckard. Markets First Alliance Will Refund $60 Million Financing. June 7.. 2001. 264 B. Orange County (Cal.R.. [Fn511].. In re First Alliance Mortgage Co. [Fn502]. The Predatory Lending Fracas: Wall Street Comes Under Scrutiny In The Subprime Market As Liqui dity Suffers And Regulation Looms. Abstract available at 2000 WL 19064943. Cal. Times. Id. Spokesman-Rev. Times. Feb. Fleischer & Amy J. [Fn506]. [Fn505]. Henriques & Lowell Bergman. A copy of the FTC complain t against First Alliance can be found in Mark D. 2000. [Fn500]. 15. 20.) Reg. Mar. [Fn503]. As of Dec. the company had assets of more than $112 million. Abstract available at 2000 WL 19064943. See ABS World Warily Eyes New Suit Against Lehman. 641 (C. 24.. Mar. 2000 WL 4817806. Kelleher. 24. 11.Y. 503 (2002) Survive Tough Times. Troubled Lender Seeks Protection. at 1C.A. 35 Creighton L. Mar. 2001).) Reg. 2000. Mar. Mar. San Diego Union & Trib.. Fast Talk and Home Equi ty Wall Street Loves Fir st Allian ce.

9. 2001 WL 8192793. available at http://www. Eur. Gramlich. Real Est.. Curbing Predatory Home Mortgage Lending 109 (June 2000).. 16. 2001. at 4. 2001). Paul Beckett. [Fn520]. . Apr. at 6 (April 10. at 20. Mar. [Fn517]. 2002. at http:// www." and ceased using single premium credit insurance. Elec. Dec. Today. Fin. 1.hud. 2002) (commenting on proposed changes to HOEPA). Trend. Id. 35 Creighton L. Mike Sorohan. See also Commission Alleges Sales Abuses by 2 Citigroup Units. Real Est. 2000. 2001 WL 9321630 (citing a special survey by the Office of Thrift Supervision). at C1. 2000 WL 8249743. Senate Votes to Pass Bankruptcy Reform Bill. Mar.htm (last visited Mar. Page 102 [Fn515]. Rev. 14. 2002). [Fn526]. Ed. FTC Charges Subprime Lender with Abuse. Oct..--U. Banker. 2001.000 brokers.pdf (last visited Mar. [Fn529].gov/epc/predlend/ (last visited Mar. [Fn525]. ABS World Warily Eyes New Suit Against Lehman.fdic. Fin. Fin. 2001).. [Fn521]. 2000. at 28. 7. June 26.. [Fn523]. Mar. May 8.. and the Holder in Due Course Doctrine.. Real Est.. 2002). Ed. 2001 WL 8192660. 9. as it reportedly stopped doing business with over 4. Id. 2001. 2001. 6. to the Board of Governors of the Federal Reserve System (Mar. Ct. Citibank may be trying to clean up the lending practices of Associates. Asset Sales Rep. 2000 WL 4666934. Dep't of Housing and Urban Dev. Haz el Ruffin Got a Loan . Citigrou p Inc. Securitization.gov/library/bookshelf18/pressrel/treasrpt. 2000. Although the language of HOEPA already seems clear. at 131.ftc. How Far Should Florida Go in Curbing Credit?. Mike Vogel. [Fn524]. 1242 PLI/Corp at 11. Mike Sorohan. [Fn522]. at 4. Erick Berquist. Elec. Dec. Mansfield. Regulators Pr ess Cit igrou p for Data in Suit. Preparing for a Bad-Loan Boom. 2002 WL 11485547. Am. 2001 WL 12285331 (noting th at the FTC filed complain ts against two Citiban k subsidiaries. see also Mike Sorohan. Apr. 2002 WL 2462793.. Dealers' Dig.S. [Fn527]. Predatory Lending Definition Challenges Enforcers. (LRP) No. Chris De Reza. Spring Fever for Predatory Lending Bills. Open Forum: Predatory Lending and Mortgages. Today. Real Est.gov/be/v010004. available at 2001 WL 8192996. Elec. 23.S. 2000." See Letter from the FTC. U. 18. [Fn519].300 foreclosures "over concerns about the original Associates loan. [Fn528]. Fin. and Associates Corporation of North America). Wall St. Fla. 19. Ed. Associates First Capital Corp. the Federal Reserve Board has proposed a "clarification" that HOEPA does in fact eliminate the holder in due course doctrine for high cost loans. [Fn514]. [Fn516]. Best's Rev. 503 (2002) 22. at 1. [Fn518]. a proposal that the Federal Trade Commission opposes because it could be used by targets of current FTC action as a basis to claim that the holder in due course doctrine survived HOEPA even in high cost loans before the "clarification. Today. 7. 37 Bankr. suspended more than 1. 2002. Dep't of the Treasury Task Force on Predatory Lending.S. Joint U. Elec. J. See Draft FDIC Staff Memorandum: How to Avoid Purchasing or Investing in Predatory Mortgage Loans (November 2000). at 2002 WL-WSJE 3356268.Held Up in Due Course: Predatory Lending. Today.. Ed. 2001. agreed to pay as much as $20 mill ion. Edward M. at http:// www2. Nat'l Mortgage News. 7. Inv. June 25. Apr. If Trusts Were To Break Wid e Open: Th e Shake-Up in Subprime Len ding an d Its Impact on ABS. 2000 WL 25345973. Cities Take Up Predatory Lending Battle Cry. 2002. 2000 WL 3953601. 1. at 42.

An excel lent non -web page discussion of recent predatory lending legislation may be found in Cathy Lesser Mansfield. Fin. Legislative Update. Freddie Mac.C. Banker. seq). Ill. Am.jhtml (last visited Mar. 1089. at 1. Code § 4973(f)(1) (2002). June 15. 5. Mortga ge Bankers Associat ion of America. 2001) (last visited Mar. Code § 4970. 35 Creighton L. Meredith. Cal. available at http:// www.org/ (l ast visited Ma r. Banker. Cal. at 16. 2002). Execs Want Simplified Subprime Loan Laws. Amendments to 209 C. [Fn536]. 15. Robert E. Fannie Mae's guidelines regarding predatory lending are discussed in its list of answers to frequently asked questions.org/resou rces/predlend/ (Feb. The provisions of this division shall not apply to persons chartered by Congress to engage in secondary market transactions.org/resources/predlend/ (Feb. Code § 4973(a)(1) (2002). Code § 4973(m) (2002). Fin. For example. at http://www. while Freddie Mac's equivalent. [Fn539]. 2002). Robert E. Litan.mbaa. 5. Elizabeth C. 2001 WL 3910692. Fin. 20 02).1A (1999). 5. Stiff Predator Laws Lead Lenders to Exit. at 1. [Fn533]. Code § 2-32-455 (2000).8 (2002) ("The pr ovisions of this di vision shall not im pose liabilit y on an assign ee that is a holder in due course.n hema . Code § 4979. Securitization.org/resources/predlend/ (last visited Mar.org/Bill s (last visit ed Mar . Chicago. [Fn542]. Cal. [Fn538]. The Brookings Institution. See N. Massachusetts Division of Banks. et. Gen. Truth in Lendin g in the Year 2000.freddiemac. § 24-1. 2001. and the Holder in Due Course Doctrine. 23. See Cal. 2001) (last visited Mar . at the time this is written. available at h ttp://www. [Fn534]. at ht tp://www. Fin. 2002). Cook County. 2001). N. 1095 (2001).10 (2000) (effective Mar.00-40. § 24-1. 2001 WL 3913088. 3 NYCRR § 41. Wingrove S.com/faq/231001q. Rev.32. Lynton & Timothy P.com/news/an alysis/pred_ index. Am.C. Newspapers Report Legislative Progress on Anti-Predatory Lending Legislati on (Mar. North Car olina Anti-Predator Law A Good Model for Other States. 20 01).. Predatory Mortgage Lending: Summary of Legislative and Regulatory Activity.1E (2000). Page 103 [Fn531]. July 27. [Fn537]. Litan. A Prudent Approach to 'Predatory' Lending.M. [Fn543]. Berquist. an d the United States all have distinct an d different sets of rules against predator y lending. Am. [Fn535].1 (2001). Fin. [Fn540]. Stat.Held Up in Due Course: Predatory Lending. Ch icago."). June 15. [Fn532]. Illinois. 5. Including Testimony on Subprime Mortgage Lending Before the House Banking Committee. Cal. Fin. Am.respon siblelendin g. Gen. [Fn544]. at 1. Cal. Fin.mbaa. 2001 WL 3912254. 22. 2002). Banker. 56 Bus. an anti-predatory lending "Don't Borrow Trouble" campaign tool-kit available to some cities. 23. Martin Eakes. Banker. Law.R §§ 32. 1242 PLI/Corp 9 (2001). Code § 4973(c) (2002).mbaa. Yen. 2001 WL 3912254. 2002). Code § 4978(b) (2002). 2002). 503 (2002) [Fn530]. . was announced at Press Release. 2001.fanniemae. 6. National Home Equity Mort gage Associat ion. Assembly Bill No. 5. Cal. The Brookings Institution. 2001. at http:// www. Stat. 2001. 489 (codified as Cal. See Erick Berquist. and Coalition for Responsible Lendin g. See also Erick Berquist. A Prudent Approach to 'Predatory' Lending. Exa mples of such web pages include: Pr edator y Lendin g Resource Center. Apr.h tml (last visited Mar. at http://www. 40. at http:// www. [Fn541].

See discussion of the early warning system created by lenders and securitizers at notes 583-87. Oakland. When an economist says that [a transaction] is efficient. nine times out of ten he means Kaldor-Hicks efficient.S.M. Econ. and the accompanying text. Misconception s about Articl e 3 of the Uniform Com mercial Code: A Suggested Methodology and Proposed Revisions. 115." Id. Posner. Efficiency. even while ackn owledging how few under stan d it.M. 700. Held Up in Due Course: Codification and the Victory of Form Over Intent in Negotiable Instrument Law. 35 Creighton L. [Fn559].070 (2001). consumers' lack of knowledge precludes the assumption that each has acted in his or her self-interest to maximize his or her wants. Rev. the test to determine whether a transaction benefits both parties is whether the transaction is bilaterally voluntary and informed. infra. with the potential liabilities that implies. L. Rev. 2001-027338 (Cal. at 13-15.. supra note 554. See Jules L. Rethinking Freedom of Contract: A Bankruptcy Paradigm. 56 J. Posner. Cal. [Fn550]. Cal. [Fn557]. 12361 C.273 (2002). 35 Creighton L.. Lary Lawrence.. 503 (2002) [Fn545]. Economic Analysis of Law 13-14 (Aspen. Schwarcz.M. My Way and the Highway: the Law and Economics of Choice of Forum Clauses in Consumer Form Contracts. Cal. . [Fn551]. Goldman notes: [M]arket imperfections.33. stating: "[T]he word order warn s the m ortga gor that he or she is signing a negotiable instrument. Rev.050 (2001). 8 Hofstra L. 721 (1992). Ct. American Financial Servs. 512-513 (1980). Page 104 [Fn549]. See Milton Friedman.. Capitalism an d Freedom 13 (1962). Perhaps many . City Council Ordinan ce No. U.040 (2001). Oakland. 5. Richard A. (2001). L. See Comments of the National Consumer Law Center and Consumer Federation of America to the FDIC on Predatory Mortgages.. Similarly. Pol. [Fn547]. Case No. Oct. Lee Goldman. 5. Rev. Rev.C.S. 288-93 (1948).33. [Fn546]. Law. because "[t]he conditions for Pareto superiority are almost never satisfied in the real world. especially those contributing to consumers' imperfect knowledge. Utility. the operating definition for efficiency in economics must not be Pareto superiority. The consumer's signature cannot be viewed as a voluntary acceptance of terms that will necessarily result in wealth maximization.C.org/predatory_lending/fdic. [Fn556]. 86 Nw. Porter. 12361 C. Oakland. see Milton Friedman & Leonard J. Oakland. Id. at 14-15. 12361 C. 12361 C. 1998). Sup. 560 (1999). 279. For a discussion of how rational consumers price risk to factor it into their choices. at http:// www. 152 (1983) (footnotes omitted). City of Oakland.Held Up in Due Course: Predatory Lending. [Fn558]. Coleman. [Fn552]. City Council Ordinan ce No. and the Holder in Due Course Doctrine. [Fn560]. 77 Tex. undermine the core postulate of the classic Chicago School model. Consumers cann ot 'voluntarily' accept terms of which they are unaware. 2002).html (last visited Mar. and Wealth Maximization. 515. According to Milton Friedman. 363. 62 N. Rev. Savage. [Fn553]. Posner states that. 12-APR S. 2001) (verified complaint) (on file with the Creighton Law Review). L. Nelson and Whitman defend the r ule. The Utility Analysis of Choices Involving Risk. City Council Ordinan ce No. City Council Ordinan ce No. [Fn554]. 18 (2001). The Two Faces of Truth--in Lending.S. 15.nclc.33. [Fn555]. 26. Ass'n v. Cal. 509. See Philip S. Securitization. 5th ed.S. Steven L. [Fn548]. 423 n.M. 5. See discussion of state's independent action in Kurt Eggert.

and the accompanying text. Th e Efficient Consumer Form Contract: Law and Economics Meets the Real World. Nelson & Dale A. 24 Ga. Eric A. [Fn569]. Rev. it presupposes a policy judgment that despit e the growth (1) of our commer cial ba nking system. L. supra. 91. Llewellyn.. 63 Yale L. discussed in section IV(C) supra." as all three parties have a hand in creating the conflict. 583. 503 (2002) Page 105 mortgagors have no idea what the word means. not seek to split it. Menachem Mautner calls this confli ct between two victims of a con artist. 44 Colum . 599 (1990). a "triangle conflict. 90 Mich. [Fn561]. 35 Creighton L. Mautner also notes that these triangle conflicts may be analyzed as accidents. concluding that even wise alterations might be too disruptive if applied so late in the day. Rev. when few of the r esiden tial borrower s affected know of th e rule which Nelson and Whitman assert is clear? See section VI(C)(4). The Commer cial Doctrine of Good Faith Purchase. [Fn565].5 (19 44)." Gran t Gilmore. But what importa nce is clar ity. Michael I. See Am. . 299. Rev. Rev. Karen Eggleston. 1057. Is there not similar thinking to be done about negotiability. Real Est ate Fina nce Law 390-91 (4 th ed. In hi s article. Ass'n v. and (4) of our also not undeveloped system of policing bankers' credit risks--despite all of these things (and with bankers constituting the over whelming mass of holders in due course of comm ercial pa per ) we shall go on applying th e "party versus party" legal mach iner y for seein g the issue and solving it whi ch goes ba ck to th e commer cial a nd fin ancial conditions of Lord Holt. He wrote. Fin.Held Up in Due Course: Predatory Lending. and (2) of our insur ance system. [Fn564]. and the Holder in Due Course Doctrine. Whitma n. U. 321 n. "The External Triangles of the Law:" Toward a Theory of Priorities in Conflicts Involving Remote Parties. 200 1).N. [Fn568]. Posn er & Richar d Zeckhauser . that we sh all thr ow th e total loss one way. Serv. in a fascinating footnote to his chatty article Meet Negotiable Instruments: Negotiability pr esupposes a policy judgm ent. As we have seen from t he exampl es of First Allia nce and GDC. [Fn563]. 767 F.. 1098 (1954). even lar ge. 97 (2000). in the banking system of the day. Rev. And so he stepped back from the brink. FTC. Securitization. L. Cir. a nd (3) of our n ot wholly negligible m achinery for the p olicin g and prevention of frauds an d forger ies. to ex plain. Id. to borrowers." Grant S. See discussi on at notes 255 and 503.C. but also its effect is not even clear. The Design and In terpretati on of Contracts: Why Complexity Matters. The holder in due cour se doctr ine is "hard. Meet Negotiable In strumen ts. but the rule is clear. It would seem plain that the agency-or-sale approach to collection risks requires rethinking in the light of the modern institution of deposit-insurance. 95 Nw. [Fn566]. one migh t ask. Karl Llewellyn performed perhaps the first economic analysis of the holder in due course doctrine and recognized that the doctrine was. 1985) (stating that HDC rule promulgated "to prevent consumers from being victimized by a counter-intuitive legal doctrine"). in terms of risk-spreading and of risk-reduction? I offer no answer. to lenders or even to judges. probably an inefficient method of resolving the dispute between the borrower and the holder in due course of a note. L. but typically only the two victims will bear any of the loss. and the accompanying text. (the original victim and the innocent purchaser of the interest obtained from the original victim by fraud). appar ently well-funded organi zations can stra nd thei r victims wit hout adequate recourse by declar ing ban kruptcy.J. Much more deeply and much more dubiously. conscious or unconscious. at 102. Evidence th at subprim e borrowers are r egularl y entering into loan agreemen ts that do not benefit th em can be seen in the mounting numbers of foreclosures of subprime loans. today. See discussion of the real defenses in note 102. discussed in notes 366-67. L. [Fn567]. supra. all the same. Meyerson. using the same "efficiency imperative" developed for tort accidents. for the argument that the holder in due course rule not only is relatively unknown by the borrowing public. as well as in the staggering percentage of subprime borrowers who would have qualified for prime loans. and the accompanying text. 980-81 (D. supra. 95 (1991). but noting that ther e might be material differences in how "personal" and business instruments should be treated. K.2d 957. infra. [Fn562].

Rev. 2002). [Fn576]. Rev. 2002).htm (last visited Mar. Predatory Mortgage Lending: The Problem. 107th Cong. I have added loss activity assignment. on behalf of the Mortgage Bankers Association).U. L. [Fn582]. 67 (1987). 363. 66 Tex. Unity In Tort. Central Pacific Mortgage Co. Rev. Courson states: "[T]he complexity of the current system is the camouflage that allows unscrupulous operators to hide altered terms and conceal crucial information without fear of the consumer discovering or even understanding the import of the masked or un disclosed items. available at http://banking. and loss spreading in A Theory of Loss Allocation for Consumer Payments. 887. [Fn580]. L. 66 F. 11. [Fn572]. L. [Fn571]. Cooter & Rubin. [Fn574]. [Fn573].sena te. [Fn581]. Perry. 66 Tex. Rev. Robert Cooter. at 73. On Banking. former top mor tgage regulator for the State of Illinois). 66 Tex. An Econom ic Case for Comparative Negligence. (2001) (testimony of John A. thus inducing each to take precautionary measures). Courson." Id. Damages for Breach of Contract.. 2000. Rubin. Central Pacific Mortgage Co. detail ed three of these four principles. Louis Dispatch. See Robert Cooter & Melvin Aron Eisenberg. loss imposition.senate. at 4. On Banking. Robert D. See also Robert D. Securitization. 499 (1961). 73 Cal. (2001) (testimony of John A. See discussion of predator y lending ch arges against First Alliance and other subprime lender s in section V(B) supra. at 74.htm (last visited Mar.Held Up in Due Course: Predatory Lending. a t 56. To these. Rev. 70 Yale L.J. 107th Cong. see Kurt Eggert.Y. Cooter & Rubin. Impact and Responses: Hearing Before the Senate Comm. 2000 WL 3537854 (offering advice to borrowers for avoiding predatory loans). Courson. 1464 (1985) ("Incenti ves for pr ecaution [i n contract] ar e efficien t if th ey compel the pr omisor to balance th e cost of his precau tion against t he cost of failing to t ake pr ecaution. President and CEO. L. L. [Fn577]. and also Lincoln Nat. Held Up in Due Course: Codification an d the Victor y of Form Over Intent in Negotiable Instru ment Law. Th e View from Springfield. Rev. 35 Creigh ton L. 1. For a discussion of the complexity that security to a loan inevitably causes."). 894 (8th Cir. 503 (2002) Page 106 [Fn570]. Rev. 1067 (1986) (arg uing tha t compa rative negligen ce is an effective system because it allocat es some r isk of loss to all parties to a loss. at 69 (discussing the "incomprehensible legalisms of form contracts and statute books" in consumer payments contracts). in which the judge held that such a complex loan document should not be negotiable because it could too easily become a trap for the . Mortga ge Banking. Rev. 3-29 (1985). L. namely loss reduction. and Property: the Model of Precaution. President and CEO. Some Thoughts on Risk Spreading and the Law of Torts. 11. Ma r. 73 Cal. Home Buyers Should Be On the Lookout for Predatory and Abusive Lending. "Jack" Seymore. [Fn575]. L.gov/01_07hrg/072701/courson. this issue will not be addr essed separat ely outside of this footnote. Cooter & Edward L. Therefore. [Fn578]. 1895). a detailed discussion of which can be found in Guido Calabresi. [Fn579]. Rev. 1. Impact and Responses: Hearing Before the Senate Comm. available at http://banking. and the Holder in Due Course Doctrine. at 127. Id. 35 Creighton L. includin g the risk to the promisee of losi ng his share of the contract's value. 63. Housing and Urban Affairs. July 20. Cooter & Thomas S. on behalf of the Mortgage Bankers Association). 1994 WL 13436253 (repor ting an interview with Joh n D. Loss activity assignment appears to be a toss-up in the question of assigning risk of loss between investors and borr owers. Bank v. 66 Tex.gov/01_07hrg/072701/courson. 1432. See a lso Cooter & Rubin. See Michael Ferry.. 61 N. Ulen. Predatory Mortgage Lending: The Problem. 401-03 (2002). 1994. sale and coll ection of the loan s. St. since both a re fairly equally engagin g in th e creation. Housing and Urban Affairs. See Jerry Demuth. Contract.

[Fn585].com/finance/smm/oct97/html/oct9 7. [Fn589]. L. Legal Studies 277 (1972). 200 2). See Predatory Mortgage Lending: The Problem. [Fn587]. See Michele M. on behalf of the Mortgage Bankers Association)." Cooter & Rubin.gov/epc/predlend/ (last visited Mar. correlates with th e size and natur e of the party. at http:// www. Beginning in 1995. See John H. Fair Lending an d Predatory Analytics for Lenders. Paying For th e Deal: An An alysis Of Wire Tr ansfer Law An d Internation al Fina ncial Ma rket Interest Groups. U. at 73-77). 26.Held Up in Due Course: Predatory Lending.htm (last visited Mar. [Fn584]. See Draft Memorandum from the FDIC Staff. 2002). eds. The Mortgage Bankers Association has contracted with MARI with regard to this database. Online. at 75. available at 2000 WL 23831258. See Comments of the National Consumer Law Center and Consumer Federation of America to the FDIC on Predatory Mortgages. Before the Senate Comm. See also Robert Julavits. Housing and Urban Affairs. 83 The RMA Journal 66 (2000). (2001) (testimony of John A. Cooper.fdic. at 77 ("Th e respon siveness element of loss reduction . 42 U. See discussion of the inherent difficulty of the holder in due course doctrine in notes 560-65. 9. supra.fredd iemac. According to Cooter and Rubin: "The parties' responsiveness to liability rules depends on their knowledge of law and their ability to factor this information into a calculus of costs. 503 (2002) unwar y. [Fn591]. reprinted in Th e Economics of Contract Law 154. Burton. Feb. Rev. [Fn588]. at 11. and the accompanying text. 1979). [Fn593]. Cooter & Rubin. 66 Tex. 2002). Securitization. available at http://banking.org/predatory_lending/fdic. Rev. 107th Cong. [Fn592]. 2001 WL 3909474. [Fn590]. . On Banking. (2000) (statemen t of Will iam Apgar . and the accompanying text. 11. Mortgage Industry Turns Up Heat on Fraud Artists. the Mortgage Asset Research Institute (MARI) has provided a national propriet ary database kn own as the Mort gage Indu stry Data Ex change (MIDEX) which collects reports of alleged fraud and suspi cious incidents a nd th e companies a nd in dividuals i nvolved identified by law enfor cement or regulators as acting illegally or improperly.. 13. Rev. On Investi gations. [Fn595]. New Directions in Tort Law. 163 (Kronman & Posner. Rev. particularly for losses t hat arise infr equently and invol ve esoteric laws. 106th Cong. 66 Tex.htm (last visited Mar. L. Banker.nclc. Impact and Responses: Hearing Before the Senate Comm. See discussion of the requirement of standardized documents for securitization in note 218. at http:// www2. L.html (last visited Mar.gov/01_07hrg/072701/courson. Cooter & Rubin. Mortgage Mkts. [Fn596]. Rev. 66 Tex. This process is discussed in notes 583-87. 30 Val. 704-05 (1994) (citing Cooter & Rubin. at 75. [Fn586]. and the accompanying text. 667.sena te. 2002). 1997. Kan. HUD's Government Insured Mortgages. Sec. 66 Tex. 864 (1996) (making this argum ent regarding th e injured victims of torts). See Guido Calabresi & Jeffrey O. Walczak. and the Holder in Due Course Doctrine. 35 Creighton L. Rev. at http:// www. Ass't Secretary for Housing/Federal Housing Commissioner. 859. Page 107 [Fn583]. See generally Balvinder S. Rev. [Fn594]. Raj Bhala. supra. Courson. Industry Stepping Up Efforts to Thwart Loan Fraud. President and CEO. L. L. 9. Central Pacific Mortgage Co. How to Avoid Purchasing or Investing in Predatory Mortgage Loans (November 2000). June 30. 2000).. On Government Affairs Permanent Subcomm . for example. supra. San gha & Anne Ker ttula. L. Oct. Am."). 1 J. 2001. The Economic Basis of Damages for Breach of Contract. like the innova tion elemen t.

1998 WL 8993225 (testimony of Jodie Bernstein of the Federal Trade Commission Mar.com/corporate/reports/ (last visited Mar. Rev. Central Pacific Mortgage Co. Fraudgate. Mort gage Banking. [Fn604]. Housing and Urban Affairs. 35 Creighton L. "Consumer protection. On Investi gations. at h ttp:// feder alreserve.44. Jan 21. Housing. 16. For a descri ption of recent. at 1825. See Abdighani Hirad & Peter M. Rev. 2000.. is likely to increase at a decrea sing ra te in response to furth er liability. Impact and Responses: Hearing Before the Senate Comm. 2002) (reporting the testimony of Dan Immergluck of the Woodstock Institute). at 42-43 (reporting the testimony of Dan Immergluck of the Woodstock Institute). 1. See Predatory Lending Practices: Prepared Statement on Home Equity Lending Abuses in the Subprime Mortgage Industry: Hearing Before the Senate Special Comm. Cooter & Edward L. 2000). at 92. See Transcript of the Federal Reserve Board Morning Session of Public Hearing on Home Equity Lending (Aug. Courson.htm (l ast modified Feb. 2002) ("Loan transactions. making it difficult for the average American to und ersta nd loa n ter ms. L. on behalf of the Mortgage Bankers Association). 2002). and Responses: Hearing Before the Senate Comm. Rev.gov/01_07hrg/072701/brenbaum. 2000). Rev. Before the Senate Comm. Mortgage Servicing News. and Urban Affairs. 43. 2000.gov/Events/PublicHearin gs/20000816/20000 816. [Fn602]. without learning of the assignment of risk. 2002). 11. July 27.senate. at 73.gov/01_07hrg/072701/courson. and the Holder in Due Course Doctrine. See also Predatory Mortgage Lending: The Problem.. [Fn606]. 26. classroom counseling 26 percent reduction. Robert D. On Banking. [Fn599]. [Fn600]. learning by itself would come to naught. and telephone counseling: no statistically significant impact on borrower delinquency. Predatory Mortgage Lending: The Problem.Held Up in Due Course: Predatory Lending. On Banking. ext ensive efforts by th e mortgage industry to insti tute effective methods of investigating mortgage fra ud. Cooter and Rubin distinguish responsiveness and learning as separate elements of the operation of the loss reduction princi ple. See Cooter & Rubin."). and without any resulting responsiveness. home study 21 percent reduction. On Aging. (2000) (statemen t of Will iam Apgar . 16. Investment in Technology Boosts First Union's Master Servicer Rating. at http://www. and that counselin g and consumer protect ions m ay be available. [Fn607]. 2001). 66 Tex. 105th Cong. at http:// federalreserve.htm (last visited Feb. can be the most complex transaction in a typical consumer's lifetime.freddiemac. parties cannot be responsive to it. but at t he same time note that learning is a dynamic factor of responsiven ess. [Fn603].gov/Events/PublicHearings/20000816/20000816. I have chosen to analyze them together because.. 2000). Nov. President and CEO. 16. 200 0 WL 12170912. On Government Affairs Permanent Subcomm . [Fn601]. . 66 Tex. 2002). (2001) (reporting the testimony of David Berenbaum of the Nat'l Community Reinvestment Coalition. (1998). 106th Cong. 9. [Fn598].htm (last visited Mar. Impact. Ass't Secretary for Housing/Federal Housing Commissioner. Rubin. L. 63.senate. ch oice of products. 90 (1987). 503 (2002) Page 108 [Fn597]. at http:// banking. Zorn. at 34. A Little Knowledge Is a Good Thing: Empirical Evidence of the Effectiveness of Pre-Purchase Homeownership Counseling 2 (2001). 14. (2001) (testimony of John A. 14. June 30. 107th Cong. L. 1998). see Dona DeZube.htm (last visited Feb." Cooter & Rubin. 107th Cong. HUD's Government Insured Mortgages. Securitization. 2000 WL 18803128. [Fn605]. 66 Tex. See Transcript of the Federal Reserve Board Morning Session of Public Hearing on Home Equity Lending (Aug. A recent report by researchers for Freddie Mac reports the following rates of reduction in 90-day delinquency rates on mortgages for the following types of counseling: individual counseling: 34 percent reduction. A Theory of Loss Allocation for Consumer Payments. available at http:// banking. available at 2000 WL 23831258. particularly mortgages.

503 (2002) Page 109 [Fn608]. discussed in section II(D) supra."). 2d 490. [Fn621]. at 518. 722 (S. and decisive liability rules. 805. [Fn610]. then it must be because they value the smaller amount of money more for each dollar than they value th e chance at the larger amoun t of m oney. 1999). 35 Creighton L.J. Rev. 2000). 1998). Economic Analysis of Law 12 (Aspen 5th ed. See discussion of HOEPA in section V(A) supra. Va. at 78 ("If reallocating the loss is required for increased efficiency.12. [Fn614]. at 496-97. Supp. W. this was even then not a novel proposition. in the Diamond/Obie cases. 723 (S. [Fn612]. J. 2d at 495. 66 Tex. Hays. 2d at 724. 494 (S. Va. 78 U. and the Holder in Due Course Doctrine. L. [Fn618]. Id. Securitization. [Fn624]. [Fn622]. Rev. more than they value a smaller chance at obtaining a much larger amount. However. [Fn625]. or could be certain to get. 93 F. Pa. As Guido Calabresi noted in 1961. 46 F. W. Supp. Posner.. See discussion of the difficulty of obtaining uniform results in applying the holder in due course doctrine and how that doctrine is often overruled by TILA. at 71.Held Up in Due Course: Predatory Lending. England. Supp. Va. [Fn615]. Supp. apparently with the idea that if people value what they already have. 2d at 497 n. [Fn613]. Feezer. Calabresi. England v. Guido Calabresi. then the most desirable enforcement process is the one that will shift liability as cheaply as possible from the creditor to the party that should suffer the final loss. 46 F. simply because particular instances can be found where the marginal utility . Id. MG Invs. Some Thoughts on Risk Distribution and the Law of Torts. Calabresi d ispar ages the th eory of the diminish ing marginal utility of money. 70 Yale L. See Cooter & Rubin. W. 809-10 (1930)).W. 2000). L. either before arbitrator s or trial judges. Va. 46 F.S. Given th at both Advan ta and Bankers Trust clai med to be holders i n due course in these two publish ed decisions. [Fn623]. at 497. [Fn609]. See also the discussion of HOEPA's limited abrogation of the holder in due course doctrine for HOEPA loans in notes 409-13. and the accompanying text. Rev. Hays v. Id.D.D. 2d 490 (S. This goal can be achieved by fashioning simple. Bankers Trust Co. [Fn619]. one wonders how often they both claimed to be holders in due course in unpublished cases. Supp. Capacity to Bear Loss as a Factor in the Decision of Certain Types of Tort Cases. 93 F. The second lender al so apparently became defunct. 2d 718. Supp. W. 517 & n.. 2d 718. though in a way non-uniformly applied by the courts.49 (1961) (citing L. Id. [Fn611]. supra.D. 70 Yale L. 1999). See 15 U.D. § 1641(d)(1).C. [Fn620]. [Fn617]. clear. Hays. Richard A. 499. Supp.. Inc. [Fn616]. 93 F. Posner views t he ri sk aver seness of people in gen eral as a cor ollar y to the dimin ishi ng marginal utility of money. 46 F. stating that then-recent studies indicate that a loss of a relatively small amount of money can have nearly as significant an effect on an individual as a much larger loss if they each cause approximately the same change in the person's social position.

2 Conn. such an allocati on of risk may damage society by discouraging the accumulation of wealth and the energetic endeavors that produce wealth. Goetz & Robert E. [Fn627]. at 48. [Fn639]. Rev. 783. 66 Tex. Rev. 99 Yale L. Bus. 204-13 (1992). U. 288. Reilly. 329. Maggs. See Gregory E. 32 Ga. so long as one is mindful that exceptions exist. Rev. Priest. Korobkin & Thomas S.Held Up in Due Course: Predatory Lending. Efficiency and Equity: Wh at Can Be Gained by Combining Coase and Rawls?. 1998).C. Rev.J. For the m ost complete explication of thi s argument. and the Holder in Due Course Doctrine. 1 992 Colum. Pena lties and th e Just Compensat ion Prin ciple: Some Notes on an Enforcem ent Model an d a Theory of Efficient Breach. The FDIC as Holder in Due Course: Some Law an d Economics. the ideal would be for all insureds to be in one gr eat pool so that the burden of all accidents would be evenly distributed among all people. See Calabresi. Posner. T he Holder in Due Course Doctrine as a Default Rule. Richard A. Fischer. See Guido Calabresi. However. Arguably. 2 (1996) (arguing that not only is determining who can most efficiently obtain insurance useful in formulating general legal doctrine. Rev. [Fn636]. 798 (1998) ("A waiver of defen se clause (also known as a "cu t off" or "hell or high wat er" clause) says that th e obligor under the contract waives the right to assert defenses against subsequent assignees. [Fn634]. "[F] rom the stan dpoint of total loss spreading. Alexander. [Fn626]. The Current Insuran ce Crisis and Modern Tort Law. L. Mortgage Prepayment: The Trial of Common Sense. 783 (1998). Id. Frank S. Rev. Calabresi noted the insurance effect of pools of mortgages even before the advent of securitization. "allows issuers and in vestors to hedge against risks associated with individual mortgages by aggregating mortgages from different geographical areas"). Securitization.J. Scott. Economic Analysis of Law 16 (Aspen 5th ed. 96 Yale L. [Fn630]. [Fn633]. Posner. Id. 1998). 165. Charles J. 87. 330 (1987) (stating th at the secondary mar ket. . includin g securitization . Marie T . supra note 627. 35 Creighton L. using a consumer installment contract as an example.J. Rev. L. Ins. Richard A. 32 Ga. 1521 (1987). see Greg ory E. Cooter & Rubin. Economic Analysis of Law 128 (Aspen 5th ed. The Costs of Accidents: A Legal and Economic Analysis 39-67 (1970). L." Calabresi. Ma ggs. [Fn638]. 554 (1977). L. 72 Cornell L. but also that the presence of insurance in a particular case tends to determine the assignment of risk of loss in that case). or that loss allocation would be sufficient to dampen anyone's desir e to gain mor e wealth or will ingness to take m easur es to do so. Geor ge L. [Fn635]. [Fn628]. 503 (2002) Page 110 diminishes at a much smaller rate than is ordinary does not invalidate this theory as a general matter. 334-35 (1998). Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules. L. Rev. Ulen. L. in Russell B.C."). it is not clear that the wealthy provide more valuable service to society than the less wealthy. The Presence of Insurance and the Legal Allocation of Risk. 77 Colum. at 78. § 3-104(d). [Fn629]. See also James M. [Fn631]. 87 (1989). stating. Liqui dated Damages. L. Ian Ayres & Robert Gertner. [Fn637]. This point is made. supra. [Fn632]. 73 Wash . [Fn640]. note 627. The Holder in Due Course Doctrine as a Default Rule.

St. [Fn656]. Calabresi notes. Instead. See also the discussion of the efficiency of the holder in due course doctrine in Clayton P. Securitization. Of course. Rev. Posner." Calabresi. Consumer Credit Regulation: a Creditor Oriented Viewpoint. L. Rules. Id. and the accompanying text. 473 (1968). 68 Colum. but as we have seen. Sunstein. On the Amorality of Contract Remedies. Rev. Page 111 [Fn645]. 205. See generally. in which Gillett e concludes that the rule is efficient over all. Rev. at 816. [Fn647]. at 473. victims are unlikely to do either.. Id. Gillette. at 818. Kripke. e. Rev.185 (1981) (arguing the same regarding the default assignment of the risk of pollution from a coal company).37 (1999). L. consumers would be unlikely to understan d the holder in due course doctrine even if they were alerted as to its existence. Cass R. [Fn649]. Homer Kripke. 32 Ga. 138 n. most consumer notes are essentially contracts of adhesion. Strategic Contr actual Inefficiency and the Opti mal Choice of Legal Rules. 1992 Colum. Rev. supra. at 805. neither understood nor negotiated by consumers. [Fn657]. [Fn643]. 181. Rev. Ian Ayres & Robert Gertner. and Precautions in Payment Systems. Ayres & Gertner. Sunstein. Injurers may often obtain and act on such knowledge. Equity. 897. 111. Rev. 35 Creighton L. 26 Fla. 87 Va. [Fn650]. 1998). 82 Va. Standards. L. Reilly. [Fn644]. at 760. only if they have adequate stati stical kn owledge of the risks involved and act on that knowledge. [Fn646]. Ian Ayres. i. See Richard A.J. at 206. [Fn654].J. and if the holder in due course doctrine were to be abolished. in the consumer setting. Bus. no doubt lenders would merely insert nearly identical terms in the boilerplate of the contract and so achieve the same effect with the same lack of efficiency or intent by the consumer to waive any of her defenses. supra. Ayres and Gertner state: "While ex post each party will have economic incentives to shift costs to the . L. 101 Yale L. 237-43 (1996). at 761. 101 Yale L. See Peter Linzer. Human Behavior and the Law of Work. [Fn642]. and the Holder in Due Course Doctrine. even though the so called "r eal defenses" seem a m otley collection of defenses thrown together with little rhyme or reason. [Fn648].Efficiency. L. U. would understand that doctrine if they were alerted to it. at 91. 81 Colum. note 627. 503 (2002) [Fn641]. 445. as discussed in notes 561-66. Id. Rev. 205. this argument depends on the notion that consumers can be sufficiently alerted to the doctrine of the holder in due course. Maggs. 760 (1991). 220-21 (2001). Empi re or Residue: Compet ing Vision s of the Contr actua l Can on. 220-24. L. L. in a discussion of accidents eq ually applicable to fraud : "[F]ree ma rket determination of the value of accident costs will lead to an acceptable result only if the potential injurers and victims are reasonably aware of and take account of th e risks.Held Up in Due Course: Predatory Lending. L. Rev. [Fn655]. [Fn653]. L. 68 Colum. 87 Va. Furt hermore. [Fn651]. and the Second Restatement. and would take an active role in replacing the default rule with a separately negotiated provision. 729. with no explicit rules taking its place. 907 n. [Fn652]. Economic Analysis of Law 104-05 (Aspen 5th ed.. Id. Rev.

C. Articles 3. Goetz & Robert E. supr a. Rev. 583. Rakoff. 24 Ga. the drafting party will enter into the transaction only on the terms contained in the document. 7 J. Th e Efficient Consumer Form Contract: Law and Economics Meets the Real World. L. 777 (1995). This representation may be explicit or may be implicit in the situation.C. 1998) an d see Charles J. as n oted sup ra. (4) The form is present ed to the adh ering party with th e represent ation th at. Securitization. 69 Va. Ayres and Gertner propose an alternative to the traditional "what the parties would have wanted" theory. Rev. U. Rev. the preformulated rules supplied by the state should mimic the agreements contracting parties would reach were they costlessly to bargain out each detail of the transaction. [Fn660]. the presence of those terms will not deter customers or lead to a loss of business by the lender. (6) The adhering party enters into few transactions of the type represented by the form--few. 405." Ian Ayres & Robert Gertner. or on behalf of. (2) The form has been drafted by. See Michael I. The term s of the standardized form con tracts ar e unlikely even to be bargain ed on in th e aggr egate by consum ers ch oosing lenders wit h better ter ms sin ce. at 1177. [Fn664]. Disclosure. 412 (1991). [Fn659]. and the Holder in Due Course Doctrine. See Meyerson. Rev. 31 Idaho L. Rubin. 1177 (1983) has identified seven characteristics of contracts of adhesion: (1) The document whose legal validity is at issue is a printed form that contains many terms and clearly purports to be a contract.18 (1989) (citing Kronman. 99 Yale L. 1173. 89 n. the stan dardization of contr acts n ecessar y for securitization has effectively eliminated the loan customer's ability to bargain for form contracts with more beneficial terms. [Fn665]. in his article Contracts of Adhesion: an Essay in Reconstruction. see Rich ard A."). Scott . one party to the transaction. at least. (3) The drafting party participates in numerous transactions of the type represented by the form and enters into these transactions as a matter of routine. 87. Todd D. Fred Miller. where the h arsh terms are n ot known or understood by consumers."). 503 (2002) Page 112 other side. Edward L. in comparison with the drafting party. 96 Harv. Rev. Rev. Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules. except per haps for a few iden tified items (such as the price term).Held Up in Due Course: Predatory Lending. 96 Harv. arguing that penalty defaults would better force the parties to disclose material information to each other. 363. Rev. Posn er. L. For the more traditional view. 35 Creighton L. 967. L. 35 Creighton L. ex ante the parties have an incentive to place the risks on the least-cost avoider. 96 Harv. Rev. 971 (1983) ("Ideally.J. 42 Ala. The Mitigation Principle: Toward a General Theory of Contractual Obligation. L. 1 (1978)). L. 775. [Fn658]. but it is understood by the adherent. Learning From Lord Mansfield: Toward a Transferability Law for Modern Commercial Practice. Rev. Held Up in Due Course: Codification and the Victory of Form Over Intent in Negotiable Instrument Law. Rakoff. Rakoff. As discussed in n ote 218. [Fn661]. 4 and 4A: A Study in Process and Scope. Meyerson. (5) After the parties have dickered over whatever terms are open to bargaining. (7) Th e principal obligation of the adherin g par ty in the tr ansa ction consid ered as a whole is th e paymen t of money. 24 Ga. [Fn663]. an d the accompanyin g text. [Fn662]. Kurt Eggert. 424 (2002). 587 (1990) ("To be con sisten t with the prin ciple t hat efficien t contracts ari se from voluntar y negotiations. Rubin notes the inelegance of using the term "balance. default r ules must ap proxima te what th e parties would have agreed to had th ey negotiated the issue. at 1179." stating "the recent revisions of Articles 3 and 4 were specifically designed not to change the original balance between banks . the document is signed by the adherent. L. at 605. Mistake. Legal Stud. L. Economic Analysis of Law 104-05 (Aspen 5th ed. Information and th e Law of Contracts. Rev.

the Consumer. Consumer Credit Regulation: a Creditor Oriented Viewpoint. Rubin.. Rev. supr a. "We saw these horrible abuses of the people who are our customers. at 40. and the Holder in Due Course Doctrine. and the Institutional Structur e of the Common Law. Thinking Like a Lawyer. [Fn667]. 12 (1997). and th e accompanying text. Hillebrand. [Fn668]. Rubin. 2001. expressed his growing disencha ntmen t with th e process of revising t he U.C. See supra discussion at note 329..Held Up in Due Course: Predatory Lending. 743 (1993). 42 Ala. Rev.A. 679. See sup ra n otes 366 -67 an d the accompanyin g text for a di scussion on t he sur prisingly large number of subprime borrowers who could have obtained conventional loans with much better terms. 621 (1988). 11. Edward L. A. Professor Edward Rubin. 75 Wash. even though one observer described that balance. [Fn669]. The Code. 42 Ala. 43 Bus. Law. Acting Like a Lobbyist: Some Notes on the Process of Revising U.C. Th e Code.C. Efficiency. "Predatory Lending" Threatens Subprime Lenders. L. Equity and the Proposed Revision of Articles 3 and 4. Policies and Issues in the Proposed Revision of Articles 3 and 4 of the U. The legitimate lenders were weary of seeing their customers stolen by predatory lenders chargi ng high er interest an d fees through aggr essive and deceptive marketing." ' Edward L. Banking J. L.B. Edward L. 26 Loy." one such legitimate lender declared. 551 (1991). Securitization. 473 (1968) (observing that in a legitimate market. 694-95 (1991). Rubin. Rev. Rev. as 'a deliberate sell-out of the American Law Institute and the Commission of Uniform State Laws to the bank lobby. and the Institutiona l Structure of the Common Law.C. Revised Articles 3 a nd 4 of the Uni form Commer cial Code: a Consumer Perspective. See Gail K. the holder in due course doctrine is statistically insignificant). Rev.Q. Articles 3 a nd 4. in his ser ies of articles on the subject: Edward L. See Jim Peterson.C. general ly and Article 3 specificall y. [Fn672]. 68 Colum. Edward L. subprim e borrowers are. Rubin. L. As discussed in note 343. End of Article . Feb.A. L. [Fn670]. U. Rubin.Q. [Fn666]. 2001 WL 11595148. 35 Creighton L. such as lower interest rates and fees.C. on average. Lender Beware. [Fn671]. 1. U. 503 (2002) Page 113 and consumers. L. wh ich may to some extent explain subprim e lenders' a bility to char ge them above market ra te loans. L. the Consumer. See Homer Kripke. 11 (1997). 445. 75 Wash. less educat ed than prime borrowers. when established in 1950. who served from 1986 to 1990 as th e chair of the Subcommittee on Arti cles 3 and 4 of the American Bar Association's Ad Hoc Committee on Payment Systems. L. It was this predatory competition that led legitimate North Carolina lenders to press state legislators to pass laws designed to suppress predatory lending.

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