The federal government's lawsuit against a consumer lender owned by Citigroup Inc. is the latest attempt by regulators to battle "predatory" lending practices that target borrowers with poor credit.
Lending to people with poor credit--an area of banking known as subprime lending--has become big business in recent years. Subprime loans grew to 13% of all new mortgages in 1999, up from 5% in 1994. And the amount of such loans repackaged on Wall Street and sold to investors hit $56 billion last year, up from $18.5 billion in 1995.
But determining at what point subprime lending becomes predatory lending--and what should be done about it--is still a matter of great debate.
This year, seven states and both houses of Congress have introduced bills to rein in predatory lending. North Carolina passed an anti-predator law in 1999, and last month Virginia legislators approved two similar bills. The legislation typically targets high-cost loans but differs on definitions of what constitutes high cost.
Bankers complain that many of the proposed laws unfairly restrict legitimate subprime lenders, who usually charge higher fees and interest rates to people with poor credit to compensate for the greater risk of default.
According to federal agencies that regulate banking, predatory lending typically involves one or more of the following practices: making high-cost loans that borrowers can't afford to pay back so the lender can seize the borrower's house; inducing a borrower to refinance a loan repeatedly to charge higher fees (a practice known as loan flipping); and deceiving borrowers about the true costs and terms of their loans.
In a series of community forums held across the country last year, the Department of Housing and Urban Development highlighted cases in which loan payments consumed nearly half of borrowers' income or borrowers paid fees equaling 8% or more of the loan amount.
Most mainstream lenders typically charge 2% or less in fees for home loans and refuse to approve home loans if debt payments equal much more than a third of borrowers' incomes.
The lending industry contends that the move by big banks into subprime lending in recent years has helped clean up what an industry spokesman said was once a "Wild, Wild West" market of small, independent operators. The result has been more competition, fewer abuses, lower-cost loans and increased availability of credit, said Leland Chan, general counsel for the California Bankers Assn.
"To the extent that [big banks] can standardize the subprime market and make it more like the prime market, that lowers costs. Then the bad operators will have no place to go," Chan said.
In addition to Citigroup, other major banks with subprime units include Bank of America Corp., Wells Fargo & Co., Key Corp., First Union Corp. and Washington Mutual Inc. J.P. Morgan Chase & Co. recently agreed to buy Advanta Corp.'s subprime mortgage unit.
Consumer groups, meanwhile, have staged rallies and letter-writing campaigns to protest lending practices they say prey on the most vulnerable borrowers. Consumer advocates unsuccessfully asked regulators to block Citigroup's purchase of Associates First Capital Corp. last year, saying the consumer lender targeted the poor and minorities with predatory loans.
Associates was one of the nation's largest subprime lenders when Citigroup bought the company and merged it with CitiFinancial Credit Co.
The Federal Trade Commission, in what is billed as the agency's biggest predatory-lending action, charged earlier this week that Associates hid important information from borrowers, trained its brokers to lie about loan terms and packed loans with high-priced credit insurance. Government officials said they are seeking hundreds of millions of dollars for victimized consumers.
Citigroup said it had taken steps to address any problems resulting from Associates' past practices and criticized the government action as "counterproductive to our shared objective of ensuring the availability of attractive loan products to all borrowers."
Citibank isn't the first company to have trouble with a subprime subsidiary.
First Union shut down the money-losing Money Store, which used former baseball star Jim Palmer to pitch its loans, after paying $2.1 billion to acquire the subprime lender in 1998. Analysts blame Conseco Inc.'s $6.5-billion purchase of Green Tree Financial for most of the insurer's subsequent financial deterioration. Conseco's management team resigned and former General Electric Co. executive Gary Wendt is attempting to turn the firm around.
Other subprime lenders failed to find buyers. FirstPlus Financial Group of Dallas and First Alliance Corp. of Irvine, among others, filed for bankruptcy, and both firms are out of business. The FTC sued First Alliance six months after the firm had ceased operations, charging that the company had misled borrowers. That suit is still pending.