A History of Predatory Lending Posted By Robert Paisola from SettlementScams.Com

Overview, objectives and Introduction

OVERVIEW:

This document is written as a lesson plan for teachers and professors

and as an informative document for the interested reader. If used in

an academic environment each individual will decide if it is

appropriate for the courses taught. Throughout the lesson you will see

student questions, summaries, research questions and real life consumer

experiences which may be discussed in detail.

At the college level this document asks questions which are appropriate

for moral values classes, business law classes, ethics in business

classes and others. The effect of what we see here can be the focal

point of micro and macroeconomics classes. Management classes can study

the material from many aspects. We encourage the widest dissemination

of this document. Throughout the document we refer to teachers,

however, one may substitute the word “professor” when appropriate.

The title of this document reflects the fact that Household

International was fully absorbed into banking giant HSBC Headquartered

in London England, resulting in Household International’s new name –

HSBC Finance Corporation. The name change was effective December 15,

2004.

WEBSITE ASSOCIATIONS:

This document is associated with two web sites. They are “Household –

HSBC Watch,” a consumer advocacy and watchdog site located at

OBJECTIVES:

Teaching objectives must be measurable. Thus we require an action, a

condition, and a standard by which to measure satisfactory mastery of

the teaching objectives. Each teacher determines the standards for his

or her class, and the institution determines the overall standards. We

put forth the following example:

Given student notes taken from this lesson, the student will correctly

state three detrimental economic impacts of predatory lending. In this

example the action is to “state three detrimental economic impacts of

predatory lending”; the condition is “using student notes taken from

this lesson”; the standard is to do it correctly.

Discussion areas referencing for objectives, including new objectives

and objectives in use in classrooms, are available at predatoryloan.com

INTRODUCTION:

Every new loan that is larger than the last contributes to increasing

over-all economic instability. The outcome of such has historically

been a crash corresponding to the magnitude of this debt distortion.

John Bley, Washington State's Financial Institutions Director, at a

Federal Reserve Board hearing in San Francisco once said "Predatory

lending isn't a new problem, it's just that the name has changed. What

was once called mortgage fraud is now called predatory lending. Under

either name, our mission to investigate violations and enforce the law

has remained the same."

This block of study will show you how predatory and sub-prime lending

is active, how it began, and how it is funded. It is said that two

primary areas will kill a company’s effort to be successful in the

field of sub-prime lending. Those areas are compliance and risk

management. You will learn how these two areas contributed to

bankruptcy for some companies and lawsuits for others.

This block of study concentrates on the period from 1980 through the

present. You will learn of personal experiences from real customers,

and we will encourage class discussion of those experiences. For those

taking this class over the Internet, a discussion area is provided at

predatoryloan.com

A History of Predatory Lending With an Emphasis On

Household International and HSBC Finance Corporation

The Lesson Plan

According to The New York Times, in 1980, Congress helped launch the

sub-prime lending industry by effectively eliminating state laws

capping interest rates on first mortgages, and two years later by

ending "most state restrictions on ‘alternative’ loans".

Home Ownership Becomes a Reality

Home ownership became a reality for many households in the early 90s.

At that time, lenders began offering mortgage loans to deprived

borrowers, many with blemished credit, and the sub-prime market was

born. Predatory practices target both home buyers (20% of predatory

loans) and homeowners taking out second mortgages or home equity loans

(80% of predatory loans). Many homeowners use home equity loans to get

money for home improvements, personal or medical expenses, or to

consolidate debts. Some predatory lenders have been known to target

high-cost home improvement loans to low-income homeowners. Furthermore,

statistics show that sub-prime loan holders have FICO scores below a

range of 620 to 660.

STUDENT QUESTIONS:

1. What are the ramifications when a lender gives the borrower the

funds instead of writing checks to companies that the borrower

intends to pay off?

2. With a home equity line of credit where the borrower gets a

checkbook and disburses the funds is the lender at fault? (question

assumes students answered the first question as expected)

The Internet Comes of Age

Although the Internet existed primarily for research, it started to

become available to the general public in the early 90s. A "point and

click" interface was released in September 1993 for the Windows,

Macintosh and the X Windows System platforms. Popularity of the

graphical user interface (GUI) browser was immediate. People without

computer expertise were able to use the graphical interface and just

point and click to navigate the World Wide Web. The general public was

able to see what others were doing, as web sites started to appear.

The New York Times said limited access to capital kept the industry

fairly small until the mid-‘90’s, when "with professional investors

hungry for higher-yielding investments, major Wall Street investment

banks stepped up the volume of loan-backed bonds sold to pension funds

and other institutions." Demographically and statistically, sub-prime

borrowers earned less and properties sometimes failed to meet certain

generally accepted appraisal standards. No savings and lack of

documentation were often seen with sub-prime loans.

Federal law has addressed potentially abusive mortgage lending

practices since 1994, when Congress enacted the Home Ownership and

Equity Protection Act (HOEPA). HOEPA amends the Truth in Lending Act

(TILA) and was designed to protect consumers from high interest rates

and excessive loan fees in the home equity market. The Federal Reserve

Board is charged with implementing HOEPA regulations, which are found

in Sections 31 and 32 of Regulation Z. 12 CFR 226.31 and .32.

Between 1994 and 1996, however, annual sales of bonds backed by subprime

loans shot up from $10 billion to $87 billion, transforming subprime

lending into a massive industry. That's not what Americans

expected to see when Congress enacted the Home Ownership and Equity

Protection Act (HOEPA).

STUDENT QUESTIONS:

1. Is a sub-prime home loan always a predatory loan?

2. Is a potentially abusive loan always a predatory loan?

3. What is the difference?

4. If sub-prime lending fills a need, and the Home Ownership and

Equity Protection Act protects consumers, is the statement “That’s

not what American’s expected to see” a correct statement?

Some Lenders Were Already Predatory

Some lenders were predators prior to that time, as evidenced by a

campaign against Fleet Bank. In 1994, a four-and-a-half year advocacy

campaign by the Neighborhood Assistance Corporation of America (NACA)

culminated with Fleet Bank committing $8.5 billion to community lending

and paid hundreds of millions of dollars to settle lawsuits.

By 1996 the Internet had over 16 million hosts and was growing rapidly.

Regulators, businesses and consumer advocates learned to create web

sites. Large corporations realized that disgruntled consumers writing

websites could perform data gathering. Legal challenges, copyright

issues, privacy and security were addressed relative to the Internet.

Corporations become visible. Using the Internet, the devastating effect

of predatory lending on society became apparent to millions of

Americans.

On October 23, 1997 the date on which Household International announced

its third-quarter 1997 results, the public, borrowers, and investors

had no way of knowing what was ahead for Household International and

predatory lending. August 14, 2002 was the day Household International

announced it would restate eight years of financials going back to

1994. William F. Aldinger III left Wells Fargo to take over as CEO of

Household International in 1994.

Household International acquired Transamerica Financial Services

Company in 1997. Household also acquired ACC Consumer Finance Company

in 1997. In 1998 Household acquired Beneficial Finance Corporation.

STUDENT QUESTIONS:

1. How would you define predatory lending?

2. When investors buy bonds to make a profit what moral decisions must

they make before investing, if any?

3. When employees buy company stock as part of their retirement plan

what responsibility does the company have, if any?

4. Discuss Enron employee reactions when they realized their

retirement had disappeared.

For the teacher: All sub-prime loans are not predatory. A loan becomes

predatory when the lender alters contracts, adds assets that don’t

exist, or pads the loan. Common to all sub-prime predatory lenders are

these practices:

• Loan flipping

• Packing the loan with overpriced single premium-financed credit

life, disability and unemployment insurance

• Balloon payments

• High prepayment penalties

• Using scam home improvement companies to generate originations

• Paying kickbacks to mortgage brokers to generate originations

• Paying off low cost or forgivable mortgage loans.

Late 1990’s See Industry Changes and Problems

In 1998 Ford Motor Company sold its sub-prime finance company

subsidiary, Associates Financial Services (known as The Associates), to

stockholders for $25.8 billion. First Union purchased The Money Store

in 1998 for $2.1 billion and sold the operation in 2000.

In 1999 Bank of America and First Union Bank gained notoriety. "(Bank

of America's) NationsCredit and (First Union's) The Money Store are

among the worst predatory lenders in the country," said William

Brennan, an Atlanta Legal Services lawyer who aids clients with subprime

loans. Household International and Bank of America would soon

fight for the title of "worst".

Also in 1999, the Minnesota Attorney General alleged that U.S. Bancorp

had illegally disclosed customers' financial data. Additional states

joined the action and the company eventually settled for $7.5 million.

Between 1998 and 2000, Lehman Brothers also recognized the profit

potential in backing predatory lending. Investment Dealers Digest

reported that Lehman had risen from third place in 1998 to become the

top underwriter of residential asset-backed securities, with a total of

more than $12 billion in issues in 2000. Lehman worked closely with

First Alliance and Conseco Finance, and formed a relationship with

Household International. One of the most significant predatory

practices yet to be addressed by the sub-prime industry is giving

customers with strong credit histories higher priced sub-prime loans.

STUDENT QUESTIONS:

1. Ethics in business – While keeping company profits high is it

ethical to give a sub-prime loan to a customer that doesn’t ask?

2. Ethics in business – With a publicly held company are an office

managers loyalties to shareholders or the community? Explain.

3. Moral values in today’s society – If you knew a person could not

repay their loan at the low monthly payment you quoted to them, but

you gave them the loan anyway, are you just doing your job?

4. Evaluate and discuss this real customer complaint:

I am still very much in the thick of it with this company.

I was told by the Attorney General's office that I did not

qualify for the settlement action as my loans were

originated with the Household Corporate Office and not the

specified "branch" office.

In May of 2003, Household contacted me and stated that they

were rewriting my loans into one and that my interest rate

and balance would be reduced. I asked the loan officer what

the interest rate would be and I was told probably around

8%. Of course, I was thrilled. When I arrived in the

office, I had to wait for 4 hours, being given excuses such

as the computer systems were down and they needed the rest

of the loan documents, etc.

When all was said and done, they stated that the loan

origination office had reworked the terms of the loan, but

I was lucky to get it because of my credit standing and

payment history - I better jump on it because the company

doesn't normally do this kind of negotiation.

Instead of the 1st loan of $181000 at 11.6% and the HELOC

of $31000 at 17.9%; I was given a loan of $222300 ($212000

being the combined total of both loans) at 10.57%, still no

escrow of course and a monthly payment of $2045 (the other

payments combined were $2131). I was told that I didn't

have to sign this but if I didn't I would most likely go

into foreclosure.

I was scared and signed, as this entire situation occurred

because of a divorce in which I had to absorb all of the

debt in lieu of alimony and I support my 14-year-old

daughter. Later I find out that the monthly payment isn't

enough to cover the interest and I therefore have a

deferred interest balance. This was not discussed or

disclosed. I was told that if I made timely payments for

one year; they would reward me with a 1/2% rate reduction.

I have had a rolling late since the loan inception, after 1

1/2 years of this loan my balance is $220300 with a

deferred interest balance of $9000. This loan was based on

a house value of $172000. Housing in my area is booming,

however, I am still unable to refinance out of this loan

because of my equity position. I have been approved by

Champion Mortgage, despite my credit rating (high of 490)

and debt to income ratio; however, my home appraises at

$250000, not enough to refinance due to debt to income.

I don't qualify for any assistance with Household because I

make too much money and "should be able to handle my

finances better." My annual property tax is $2016, my

insurance is $700 and ground rent is $120. I clear $2054

every 2 weeks, I have divorce debt with a debt management

plan that runs $456 per month a car payment of $566 due to

the high interest rate and utilities that equal $600 per

month. Saving for the escrow is impossible because I don't

have the extra $236 per month to use.

I am in total financial ruin, I don't believe in

bankruptcy, I am terrified of foreclosure and I may just

lose my job due to my credit situation. My job requires me

to hold a Top Secret security clearance, a big portion of

which is based on your credit situation. I make very good

money; I have worked for the Federal Government for over 12

years and I have absolutely nowhere to turn.

Do you have any suggestions, besides throwing in the towel?

Understanding Asset Backed Securities

Earlier we said “Lehman had risen from third place in 1998 to become

the top underwriter of residential asset-backed securities, with a

total of more than $12 billion in issues in 2000.”

All asset-backed securities are securities that are based on pools of

underlying assets. The wonder of securization is that it takes a wide

variety of formerly illiquid and directly held assets and makes them

available to many investors in the form of asset-backed securities.

This simple process can be applied to all sorts of cash flow producing

assets.

If a retailer needs cash, it securitizes part of its outstanding credit

card balances from its customers into a "credit card receivables

trust". An auto-leasing firm takes the outstanding automobile lease

balances and turns them into an "auto receivables trust". A bank takes

a group of its higher quality customers and creates an "evergreen

revolving financing trust" which constantly takes high quality

receivables and finances them by issuing bonds from the trust.

Administration of the pool of mortgages is more systematic as well. We

can have the same "servicing agent" collect all the monies from all the

mortgages and "pass it through" to the investors via a central trustee.

Payments can be made to the investors at the same date each month. One

can even supply aggregate data and statistics on the pool to investors,

such as the "Weighted Average Coupon" (WAC), or "Remaining

Amortization" (RAM).

STUDENT QUESTIONS:

1. When a company sells bonds (asset backed securities) to investors

how does the transaction help the company?

2. Should investors question the validity of the securities?

3. When the same company sells stock to its employees how does it help

the company?

4. In a package of 100 home mortgages how would 1 foreclosure dilute

the package? 10 foreclosures?

Lawsuits for Predatory Lenders

Facing a flood of lawsuits over its predatory practices, First Alliance

sought bankruptcy protection in 2000 and is no longer in business,

however Lehman Brothers established a similar conduit operation with

Conseco Finance.

Conseco was once a hugely profitable financial services company. Then

it bought Green Tree, a finance company that specialized in trailer

homes and that had followed disastrously loose lending policies (see

story). Conseco experienced huge losses on the Green Tree portfolio and

in 2002 filed for bankruptcy.

Of particular interest in 1998, California’s Department of Corporations

sued Household International to stop Household from charging excessive

administrative fees after the company admitted to 36,000 instances in

which it had violated state lending laws and regulations.

According to analysts by 1999 25 percent of all sub-prime loans were

made in a predatory manner. Bank of America was the nation's largest

originator of sub-prime loans and securities in 1999, averaging monthly

volume of about $600 million, according to Mortgage Banking magazine,

through its sub-prime NationsCredit, EquiCredit, and First Franklin

Financial units.

Predatory Lending in Areas Other Than Mortgages

Throughout the mid-1990's tax refund loans also haunted consumers and

brought huge profits to tax preparer H&R Block and Beneficial Finance.

Household International in mid-1998 purchased Beneficial Finance

Corporation. Household claimed they invented the Refund Anticipation

Loan (RAL) which carries a high rate of interest. Class actions in

several states accused Block of duping consumers into taking the loans

in the mid-1990s.

Block settled a Texas class action in 2002 involving the loans and

about 700,000 class members. The settlement cost Block $41.7 million.

Block and Household had proposed a $25 million settlement with the

Chicago case's class members, who numbered about 17 million. (Judge

Elaine Bucklo rejected the settlement in April 2003.)

By November 2002 Household entered into an agreement with ITLA Capital,

wherein ITLA appeared to write contracts for H&R Block. ITLA held the

contract for not more than "23 hours and 59 minutes" after which it was

sold to Household. At H&R Block all letterhead and all contracts had

the Household International logo, not ITLA Capital, nor the actual

lending subsidiary of ITLA, Imperial Capital Bank.

Records from the late 90s indicate that Household International also

sold consumers in what often started in a benign way. East Baltimore

residents Horace and Barbara Price bought cookware and meat from a

door-to-door salesperson in a deal financed by Household; within the

year they were pressured into refinancing a new loan with a much higher

interest rate secured by their house.

No sooner did Edward and Brenda Watters of West Baltimore get an

unsolicited check for $2,500 from Household in the mail than, like the

Prices, they were urged to refinance with a high-interest loan secured

by their home.

Valerie Coffin, a researcher with the national activist group ACORN

(Association of Community Organizations for Reform Now), says such

cases are a "good example of how [Household] originally gets people in

with these consumer loans that are unsecured, (and) then they end up

flipping you into a loan that is secured by your house."

STUDENT QUESTIONS:

1. We make the statement that “let the buyer beware has been the rule

forever.” Is this a valid statement in this case? Why?

2. If a mortgage lender does not want to own the home as a result of

foreclosure why does the mortgage lender use the tactics mentioned?

Notes for the teacher: It is assumed that families will prevent

foreclosure, and prevent repossession of their automobile(s), at all

costs. The time during which they pay high interest rates often

dictates the profitability of a loan regardless of the final outcome.

By The End of the Year 2000

By the end of 2000, Household International, Citifinancial, CIT Group,

Champion and others were key factors in the sub-prime market.

Household International and H&R Block were key players in refund loans.

Household International acquired Renaissance Holdings in 2000 in an

attempt to target non-prime secured and unsecured credit card business.

Because Household is a consumer lender, it isn't required to report

loan data to federal regulators as extensively as financial

institutions that sell mortgages. That would soon change. On July 26,

2001 the Senate Banking Committee held hearings on predatory lending.

California Sues Household International Again

In 2001 the state of California sued Household International again

after discovering that "Not only did Household fail to comply in 1998,

but it began practicing even more abusive lending procedures and passed

these practices on to its sister corporation, Beneficial, Inc. As a

result, many African-Americans, Latinos and economically disadvantaged

Californians found themselves illegally nickeled and dimed by a $26

billion company"

STUDENT QUESTIONS:

1. When legal action is imperative should compensation of victims

dictate the monetary amount of a settlement?

2. Discuss the ramifications if a settlement drives a company out of

business.

3. What are the long-term economic effects of predatory lending?

4. What are the sort term economic effects of compensation to the

victims?

5. What are the advantages of a settlement that allows a company to

stay in business? What if the company does not comply with a court

order?

Sub-prime Lenders Achieve Notoriety as Predatory Lenders

In November 2000, Citigroup, co-chaired by former U.S. Secretary of the

Treasury Robert Rubin, won approval to purchase The Associates First

Capital Corp., in a $31 billion merger. The Federal Trade Commission

said The Associates is notorious for making predatory loans, charging

in a March 2001 federal suit that The Associates has engaged in

systematic and widespread abusive lending practices, commonly known as

predatory lending. The Associates was facing more than 700 lawsuits

regarding predatory lending, involving a total of $19 million.

Citigroup merged The Associates with their own predatory business unit,

CitiFinancial.

Lehman created subsidiary companies (Aurora Loan Services and Lehman

Brothers Bank) in order to directly acquire and service sub-prime

loans. Pension funds invested heavily in bonds sold by mortgage

lenders.

From 2000 to 2002 some sub-prime lenders achieved notoriety as

predatory lenders. Public pressure, legal actions, and pressure from

shareholders started to change the face of predatory lending. Class

action suits, ERISA fraud, public outcry and nationwide settlements

impacted the predatory lending sector by 2002. Consumer activists at

Household Watch concentrated on the credit card market, while ACORN

activists continued to monitor sub-prime and predatory lending. Both

organizations protested the acquisition of Household International by

banking giant HSBC.

STUDENT QUESTIONS:

1. What is the impact on country’s economy if predatory lending is left

unchecked?

2. Do you think borrowers forgot about “The Associates” after the

merger by CitiFinancial?

3. Do you think borrowers associate CitiFinancial with predatory

lending due to the past record with “The Associates”?

Financial Institutions Turn to Credit Cards

It is important to note the difference between a financial institution

that services the sub-prime market and a financial institution that is

predatory in nature. The sub-prime market is a valuable market that

requires fair and equitable lending, although the rates may be higher

correlating to higher risk for the lender. To abuse or take advantage

of individuals, many of who are in the sub-prime classification because

of their credit score, employment history, or other factors, is what

differentiates a predatory lender from a sub-prime lender.

Aware of liabilities arising from blatant predatory lending, financial

organizations turned to credit cards for huge profits and a way

multiply profits from predatory mortgages. October 13, 2000 saw a

consumer lawsuit against FleetBoston accusing the bank of misleading

consumers by offering a fixed interest rate on credit cards, then

raising the rate when consumers transferred balances from other cards.

In December 2000, Providian Financial has agreed to pay $105 million

to settle a cluster of class-action suits that accused it of unlawful

business practices in its sale of such add-on products as credit

protection and credit-line increases to its credit card customers.

STUDENT QUESTIONS AND ASSIGNMENTS:

1. Is a credit card purchase a secured or unsecured loan?

2. What is the mutual trust relationship between a customer and their

credit card company?

3. Discuss the positive and negative aspects of binding arbitration as

it relates to credit card contracts. Research binding arbitration

and be prepared to discuss it.

EchoSphere v. Household – a Look Inside

An examination of court records from EchoSphere v Household gives

insight into private label credit card operations such as Best Buy's

credit card, which is also backed by Household. In the original

contract terms Household agreed to pay EchoSphere the initial purchase

amount (discounted .85%), 30% of the consumer insurance premiums,

between 6% and 10% of fees and interest collected.

Also in December 2000, the Minnesota Attorney General sued FleetBoston

Financial, charging that its mortgage group has illegally given

information about mortgage holders to telemarketers. Attorney General

Michael Hatch called the practice "sleazy" and "over the line,"

according to The Wall Street Journal.

In June 2001, with pressure mounting against selling credit insurance

in a lump sum up front to unwitting consumers, Household International

again made history. The practice, which is costly to borrowers because

they pay interest on the insurance as well as the loan, had long been

popular with finance companies but had been largely discontinued in

recent years. Household stopped doing it in June 2001, becoming the

last major lender to scrap the tactic.

STUDENT ASSIGNMENT: Research EchoSphere v. Household and be prepared to

discuss the lawsuit.

STUDENT QUESTIONS:

1. How was “ongoing compensation” profitable for both companies?

2. After the contract was terminated what was the nature of the

lawsuit?

3. Did the court find in favor of Household or EchoSphere?

4. What similar cases exist, if any?

Note for the teacher: Household v. EchoSphere is on file in the shared

Competition in Private Label Credit Cards

Private label credit cards are cards issued as though they are store

credit cards, such as a Best Buy or Levitz Furniture credit card. Many

large stores once had their own credit card portfolios, but most are

now contracted.

Citi Commerce Solutions, Household International's Household Retail

Services, and GE Card Services, major providers of third party private

label credit cards, saw competition heat up in the retail credit card

sector. Household Watch consumer advocates formed volunteer teams to

monitor Household International and Household Retail Services. By

early 2002, Household Watch was active 24 hours a day seven days a

week.

The definition of predatory lending started to change. No longer

limited to mortgages, predatory lending was redefined by Household

International and others to include predatory credit cards, while abuse

of fiduciary responsibility penetrated the entire framework at

Household International. "A fiduciary relationship would arise where 'one person is obliged, or

has undertaken, to act in relation to a particular matter in the interests of another and is entrusted with a

power to affect those interests in a legal and practical sense', and where there is a 'special vulnerability of

those whose interests are entrusted to the power of another'".

With respect to problems in the mortgage industry some financial

institutions became known for their predatory tactics. Loan flipping,

packing loans with insurance, and frequent refinancing were issues in

the mortgage industry. When some of the same financial institutions

practiced predatory tactics in the credit card industry, public outrage

began to surface and become evident. At that time a true definition of

predatory lending became clear, as practices within the industry were

not driven by market imperatives, but rather because the companies

could get away with it. If caught the fine would be far less than the

profits. Regulators would often impose a fine and would insist on

future compliance, and in return the company would neither admit nor

deny wrongdoing.

In 2002 Lehman Brothers Bank and Aurora acquired and securitized over

$700 million of mortgage loans for Household International, possibly

the most infamous predatory lender in the business.

Securities and Exchange Commission Looks at

Household International

2002 was not a happy period for Lehman as the Securities and Exchange

Commission looked at Household International. The Commission found

that, in the "Management's Discussion and Analysis of Financial

Condition and Results of Operations portion of annual and quarterly

reports filed with the Commission since March 13, 2002, Household made

materially false and misleading statements concerning its restructuring

and account management policies."

Consumer advocacy organization Household Watch submitted proof of

improper re-aging of accounts. The SEC went on to state that Household

was rolling over US$1 billion in bad loans every month by 2002.

Household International's consumer lending accounted for 62% of 2002

revenues; Credit Card service, 24%; International, 8% and all other,

6%.

By September 2002, the Federal Trade Commission said "In the largest

consumer protection settlement in FTC history, Citigroup will pay $215

million to resolve Federal Trade Commission charges that Associates

First Capital Corporation and Associates Corporation of North America

(The Associates) engaged in systematic and widespread deceptive and

abusive lending practices." While it may have been the FTC's largest

settlement, watchdog organization “Household - HSBC Watch” continued to

work closely with the FTC relative to Household Retail Services.

Websites belonging to Household Watch gained recognition from the FTC

as a source of help for consumers.

It was then that Household's CEO was caught in another possible

falsehood. William Aldinger responded to the introduction of a

shareholder resolution, with a firmly delivered, "We are not predatory

lenders." Hundreds of employee shareholders in the audience responded

to Mr. Aldinger with a standing ovation. Yet, only months later, with

the company’s stock price badly battered, Household settled the largest

predatory lending complaint in the nation’s history, agreeing to pay

$484 million of shareholders’ money. Aldinger's sales pitch to his own

company was evident. "We think this thing out there called predatory

lending is important. It's bad for our company, it's bad for our

employees, and it's bad for our customers," company spokesperson Megan

Hayden says. "I take exception to any characterization of our company

as a predatory lender."

As further proof of Aldinger's attempted sales pitch, “Household’s

position on predatory lending is perfectly clear,” said Gary Gilmer,

then president and CEO of Household Finance Corporation and Beneficial

Finance Corporation, and now retired. “Unethical lending practices of

any type are abhorrent to our company, our employees, and most

importantly, our customers.”

Analysts compared the speech to a speech by Kenneth Lay of Enron,

telling employees to invest in Enron and trust the company leadership.

Enron disclosed a stunning $638 million third-quarter loss, the

Securities and Exchange Commission opened an investigation into the

partnerships and the company's main rival backed out of an US$8.4

billion merger deal. Household International paid US$484 million in

fines and HSBC still paid US$14 billion in stock for Household

International. Mergers in the financial sector are different from

mergers in the energy sector. Bank of America was also racking up

record fines with a cumulative total of almost US$2 Billion.

STUDENT QUESTIONS:

1. In relation to moral values in today’s society, how would you

summarize the actions of Enron and Household?

2. In relation to ethics in business, how would you summarize the

actions of Enron and Household?

3. Is there, or is there not, a direct correlation between ethics in

business and moral values in today’s society? Defend your position.

In order to finance consumer purchases Household International and

other lenders sell their debt in the form of bonds to investors. $6.1

million in bonds were sold between 1999 and 2001 to Baltimore's pension

funds for its employees. In addition, employees of Household

International relied on statements from corporate leadership as many

were heavily invested in Household's stock as part of their 401-K

retirement portfolios.

The largest sub-prime mortgage companies of 2002 were Household (and

its Beneficial subsidiary), Citifinancial, CIT Group, KeyBank USA, and

Countrywide’s Full Spectrum Lending subsidiary. The largest predatory

lender of 2002, considering actions in play throughout corporate

structures, was Household International. Violations in mortgage

lending, credit cards, private label financing, and automotive

financing gained overall honors for Household International and William

Aldinger. But HSBC in London was looking at Household International,

tendering a stock-only offer for the troubled company.

In August 2002, it was widely reported that "Giant consumer lender

Household International Inc. restated its earnings, reducing them by

$386 million for the past eight years, including a cut for the six

months ended June 30 of $26 million, or 6 cents per share".

Contrasting Household with Enron, Enron officials have acknowledged

that Enron overstated profits by more than $580 million from 1997 until

declaring bankruptcy in December 2001.

For Household International "The restated first-half net income is

$998.4 million, down from $1.02 billion reported on July 17. The

reasons given were revisions to the accounting treatments of the

company's MasterCard/Visa co-branding and affinity credit card

relationships, and of a credit marketing agreement with an unnamed

third party."

November 20, 2002 -- ITLA Capital Corporation announced it has entered

into a strategic business relationship with various subsidiaries of

Household International relating to certain tax refund and private

label commercial credit card products. Specifically, “ITLA's banking

subsidiary, Imperial Capital Bank, will originate tax refund

anticipation loans in which, after the sale to Household of a

substantial non-recourse participation interest, ICB will retain a

small interest.

“In addition, Household, a leader in the structuring and implementation

of tax refund lending programs, will support credit administration,

compliance, and accounting functions with a range of services relating

to the administration of the program. ICB also has entered into a

letter of intent with Household, pursuant to which it is contemplated

that ICB will originate loans relating to private label commercial

credit card transactions in which, after the sale to Household of a

substantial non-recourse participation interest, ICB will retain a

small interest.”

H&R Block negotiated a contract with Sears whereby Block would put tax

preparation kiosks in Sears stores. In 2003 a similar deal was formed

between Block and giant US retailer Wal-Mart.

STUDENT QUESTIONS:

1. Is there a direct correlation between the desire for one company to

do business with another company, and a company’s reputation?

2. Discuss this statement: “It is easier to build reputation in a new

company than to repair a damaged reputation.”

The Home Mortgage Disclosure Act

Changes to the Home Mortgage Disclosure Act effective in January 2003

may have opened loopholes for predatory lenders.

A comment by HSBC dated 19 March 2003 said in part "HSBC, which has

been kept informed by Household of the ongoing inquiries by the US

Securities and Exchange Commission ('SEC'), is pleased that the consent

order between Household International, Inc. and the SEC relating to

Household's disclosures of its restructuring and other account

management policies has been reached. The order does not require

Household to pay fines or monetary damages. Household will not be

restating any of its financial statements."

Restatement of earnings had already taken place, for the entire period

during which Aldinger was CEO of Household International. When the

United States government began holding CEO's responsible for their

company earnings, Aldinger had to make a decision. Now held

responsible, scrutinized by regulators, facing multiple lawsuits, and

hiding facts from investors, Aldinger wanted HSBC to purchase his

troubled predatory lending company, Household International.

Unknown to the general public, from 1994 until 2004 - the entire time

during which Aldinger was CEO of Household International - there was

another skeleton in the closet. Closely monitored by consumer

organization Household Watch, what was soon to be known as "Shea v

Household" was being perpetrated behind the scenes at Household

International.

Another monumental event on May 1, 2003 saw Visa and MasterCard

agreeing to pay $3 billion to settle a suit over debit-card fees filed

by WalMart, Sears and other large merchants. An appeal was filed and

the suit held up under Supreme Court review. Household, now called

HSBC North America Holdings, is a large issuer of MasterCard accounts.

Chairman William F. Aldinger sits on the Board of MasterCard.

Also in 2003, Standard & Poor's has said it won't rate securities that

contain certain loans classified by the law as "high cost," and

mortgage-finance companies Fannie Mae and Freddie Mac said they won't

buy such loans. Fannie Mae and Freddie Mac are government-sponsored

companies that buy loans from banks so lenders can keep making loans.

Attempts are made in 2003, both at state and federal levels, to stem

the tide of predatory loans. It is important to note that sub-prime

loans should not be effected. There is a distinct difference between

sub-prime and predatory. A clear definition of predatory lending

started to emerge.

STUDENT QUESTIONS:

1. When a company settles charges without admitting or denying an

infraction, does the company have the right to continue the same

business practices?

2. Do Federal Regulations override or over turn State and local antipredatory

lending laws?

Notes for the teacher: Refer to the shared document library at

speech regarding issues and answers to question 2.

More Companies under Scrutiny as Default Numbers Don’t Add Up

HSBC's efforts to absorb Household International are ongoing but not

yet complete in 2003. Household International is now known as HSBC

North America Holdings, still under the control of William F. Aldinger

III. By 2004 HSBC applied for, and received, a national charter.

Previously chartered as a New York bank, HSBC is under the control of

the Office of the Comptroller of the Currency by 2004. The risks are

high but moving into consumer finance is definitely the method by which

HSBC can close the gap on Citigroup.

2004:

According to a source at Fitch Ratings in New York, two major mortgage

servicing organizations are being closely scrutinized a year after

Fairbanks Capital Corp. was cited for servicing violations, and settled

with the Federal Trade Commission and U.S. Department of Housing and

Urban Development; and six months since Ocwen Federal Bank implemented

measures contained in an Office of Thrift Supervision supervisory

agreement.

Historically, investors depend on default numbers as well as loss

numbers. When the SEC issued a cease and desist order against

Household International in March 2003, the SEC alleged "Restructuring

policies directly impact a financial institution's reported delinquency

rates, which analysts and investors use as a key measure to evaluate

the financial condition of a company like Household," said Mary Keefe,

Director of the SEC's Midwest Regional Office. "By making false

statements about its restructuring policies, Household made it more

difficult for analysts and investors to evaluate Household's financial

performance."

On March 19, 2004, in Orange County California Superior Court, final

settlement was reached in Shea v Household. Part of the document reads

"TO ALL MEMBERS OF THE FOLLOWING SETTLEMENT CLASS:

All consumers who have, or at any time between October 20, 1994 and

March 18, 2004 have had, one or more Household Credit Card Accounts..."

This Lawsuit alleges that Household imposed certain finance charges,

late fees, and over-limit fees between October 20, 1994 and March 18,

2004 that were not authorized by Household’s credit card agreements and

were in violation of state law. Allegations were made that Household

intentionally and deliberately applied payments to accounts late, or

after the billing cycle closed for the month.

Consumer advocacy organization Household Watch, now known as "Household

- HSBC Watch", had over 1700 consumer complaints which appeared to

support the allegations. The organization cooperated with those asking

for information relative to what was going on at Household

International. It is important to note that Household - HSBC Watch

uses customer input to perform trend analysis.

March of 2004 was not a good month for Household International.

Racketeering charges (RICO charges) against Household and H&R Block

were certified by the court. A news release from two New York law firms

representing the Chicago class said the court found the RICO complaint

adequately pleaded that Block helped operate a scheme to defraud

customers into buying refund anticipation loans. Block also has a subprime

mortgage division under the name Option One Mortgage.

"This is a very serious claim when you have a federal court allowing a

RICO claim against two corporations to go forward on a nationwide class

basis," said Peter Linden, a partner with New York law firm Kirby

McInerney & Squire LLP. Tax preparers and lenders strip about $1.8

billion in fees each year from the $30 billion in earned-income tax

credits paid to working parents, according to the Brookings Institution

Center on Urban and Metropolitan Policy.

Mutual Fund Scandal Reveals Irregularities

Bank of America continued to rack up more fines in 2004. Bank of

America, which uses the promise of "higher standards" in its

advertising campaign, has been caught up in various investigations.

Bank of America and FleetBoston have agreed to a $675 million

resolution to allegations of improper mutual fund trading -- the

biggest settlement in the fund industry scandal so far, regulators

said. (Bank of America finalized its purchase of FleetBoston in April

2004.)

Also embroiled in the fund scandal are Bank One Corp., Janus Capital

Group Inc. and Strong Capital Management. By March 2004, Bank of

America agreed to a $10 million SEC penalty for failing to produce

documents in a separate probe of trading. It also faces allegations of

issuing tainted stock research. In addition, Italian investigators are

looking into Bank of America's role in the collapse of food company

Parmalat Finanziaria SpA.

In July 2004, JPMorgan Chase and Bank One completed their merger. It

is alleged that "This proposed mega-merger would harm consumers," said

Matthew Lee, executive director of Inner City Press. "J.P. Morgan Chase

has increasingly become a predatory lender, since it bought Advanta,

and as an investment bank. Bank One funds payday lenders, and high-cost

tax refund anticipation loans."

By the third quarter of 2004 Bank of America became the leader in

willful disregard for the law and sound business practices in exchange

for profits. Household International had been the leader from 1994

through 2004. Both banks operate on an international scale; thus many

smaller predators are often overlooked as they demonstrate the same

possible willful disregard for the law.

American Express Sues Visa and MasterCard

As late as November 15, 2004 American Express sued credit card

associations Visa and MasterCard and eight banks for damages from what

it called anti-competitive practices that prevented 20,000 U.S. banks

from using its credit card products.

JPMorgan Chase and Bank of America were named in the suit because they

had been or currently are members of one or both credit card

associations' boards of directors. William F. Aldinger, Chairman and

CEO of HSBC North America Holdings, and previously the CEO of Household

International, is reported by HSBC in August of 2004 as a director of

MasterCard International Inc.

Other banks named in the suit include Capital One, U.S. Bancorp,

Household Bank, Wells Fargo, Providian National Bank and USAA Federal

Savings Bank -- among the largest issuers of U.S. credit cards in 2004.

The suit comes one month after the U.S Supreme Court rejected appeals

by Visa and MasterCard of a ruling that the two credit card

associations violated antitrust law by barring banks from issuing

credit cards for rival networks. Conspicuously absent from the suit

were two of the largest U.S. credit-card issuers: Citigroup (84.6

million U.S. cards) and MBNA (54.3 million cards). MBNA had

approximately 12 percent of the credit card market in 2004.

No monetary amount was mentioned in the latest suit against Visa and

MasterCard, but experts think the amount will be in the billions,

possibly in excess of US$10 billion. Household Watch consumer

advocates points out that the amount will be important. Although Bank

of America is the leader in cumulative fines as of this writing,

William Aldinger may have been directly and indirectly responsibility

for what is possibly the finance industry’s largest cumulative total in

America under the control of one person as either director, CEO, or

Chairman.

• MasterCard International - fined US$1 billion - upheld by US Supreme

Court

• Household International - fined US$484 million - US multi-state

settlement

• Household International - fined US$11 million - Shea v Household

• Household International - fined US$46.5 million - ERISA Fraud,

October 13, 2004

• Household International - fined US$12 million - California, February

2002

• Household and H&R Block - proposed US$25 million - rejected by the

court, April 2003

counting.

In the United Kingdom July of 2004 saw HSBC Holdings, Europe's biggest

bank by market value, agree to buy Marks & Spencer Group's banking unit

for 762 million pounds (HK$11.05 billion), giving it 2.7 million more

customers in Europe's largest credit card market. HSBC will pay 275

million pounds for the business up front, plus the unit's net asset

value of about 488 million pounds when the purchase is completed, HSBC

said. HSBC will also give half the unit's net profit, minus some

costs, to Marks & Spencer for an initial period of 10 years. Buying the

consumer-banking unit will make London-based HSBC one of the top three

British credit card issuers. The actual entity is U.S. based Household

International.

Predatory Lending Still Present in the Mortgage Industry

Also in 2004 it was evident that predatory lending was still present in

the mortgage industry. In March regulators shut down Tallahassee,

Fla.-based Guaranty National Bank for deceptive marketing and for

saddling borrowers with costly home-equity loans. Virginia-based

mortgage brokers David Shumway and Randy Bapst, whose consulting

companies were involved in Guaranty's home-equity operations, also are

under fire, having originated some 28,000 loans to the tune of $1

billion over a two-year period and pocketing $20 million each from 1998

to 2001. Two years earlier, the two men ran a similar operation for

Bumpers's lender, the Community Bank of Northern Virginia.

A successor company to the early Shumway-Bapst companies, Calusa

Investments LLC, operates from the same Chantilly office and already

markets loans in 30 states, but not in Virginia. It has attracted

criticism from E.J. Face Jr., commissioner of the Virginia Bureau of

Financial Institutions. He has twice rejected a mortgage lender license

for Calusa, writing June 30 that its principals have "an attitude of

utter disdain" for compliance with lending rules and regulations.

On July 16, 2004 Citigroup said that its net income for the second

quarter fell 73 percent after taking a $4.95 billion charge against

earnings for lawsuits related to its dealings with Enron and WorldCom.

Losses for Worldcom investors were reportedly three times larger than

Enron, at almost $175 Billion, where pension funds and others suffered

during a meltdown of the telecommunications industry.

By mid-November 2004 it was announced that British bank HSBC may make

an offer for the $3 billion credit card portfolios of Macys and

Bloomingdales owned by Federated Department Stores, according to a

published report. A bid would come through HSBC North America's

Household International. A report in the New York Post said Citigroup,

J.P. Morgan Chase and GE's consumer finance division could also be

potential buyers.

On the mortgage front, November 2004 saw Countrywide Financial

Corporation at the top of the mortgage lending and mortgage servicing

industry, according to Inside Mortgage Finance. CountryWide Financial

Corporation said "As a result of the strong focus on core businesses of

residential lending and loan servicing, Countrywide has become the

nation's largest mortgage lender and largest servicer of residential

loans." Countrywide companies made one of eight new loans nationally

and serviced 10% of all mortgages.

Finally, on December 15th 2004, Household International became HSBC

Finance Corporation.

SUMMARY:

EACH YEAR, PREDATORY LENDING DRAINS ABOUT US$10 BILLION FROM AMERICAN

FAMILIES. The best response to predatory lending poses a real

challenge. How do we promote widespread access to mortgage credit and

home ownership, while protecting consumers from abusive practices?

Perhaps a definition of predatory lending is required. Predatory

lending is the practice of imposing inflated interest rates, fees,

charges, and other onerous terms on home mortgage loans and other types

of financing for individuals and families. Onerous terms are not

imposed because imperatives of the market require them, but because the

lender has found a way to get away with them. When profits far exceed

the fines and executives are willing to sacrifice integrity for

profits, consumers and the infrastructure of the United States will be

the big losers.

In its review of THE TOP 100 FALSE CLAIMS ACT SETTLEMENTS, the

Corporate Crime Reporter said, "The federal government has the

authority to prohibit corporations convicted of serious crimes from

doing business with the federal government. This debarment or exclusion

authority is considered the equivalent of the death penalty, because

for major health care corporations and defense corporations which rely

on federal contracts, denying them federal contracts would effectively

put them out of business. The federal government rarely exercises this

authority – although it should more often to deter an ongoing pattern

of criminal fraud."

Throughout this document the reader sees where companies and

corporations neither admit nor deny wrongdoing. Ultimately the company

emerges unscathed which was the intent to begin with, thus debarment or

exclusion is not considered.

Since the late 1980’s and throughout the 1990’s credit was widely

available in the form of car loans, credit cards, and low-rate

mortgages. Perhaps European countries and developing nations should

study that period in American financial history. Ultimately, as

Americans borrowed as much as possible, sub-prime lenders found

borrowers with damaged credit or skewed debt to income ratios. The

borrowers owned homes, and the sub-prime industry blossomed. Since

real estate is a sound investment, sub-prime lenders began to

consolidate and pay off debts through mortgages while using homes as

collateral.

What differentiates a predatory lender from a sub-prime lender is

mortgage flipping, bad or inflated appraisals, asset padding, equity

stripping, and other schemes identified in this lesson which put the

borrower in a position of hopelessness.

With respect to credit cards, predatory lenders use tactics to modify

credit terms illegally, such as applying payments after the due date.

Other predatory tactics include negating “interest-free’ promotions by

losing the customer’s payment, changing the billing address of a

customer, and failing to update the customer’s address when a change of

address is submitted.

We discussed the impact of predatory lending from a business

standpoint. This lesson also interjected experiences of real

customers. It is impossible to project the human impact of predatory

lending on effected families, feelings of self worth, and one’s ability

to plan for the future. This document is unable to describe the shock

and awe felt by a family when they discover a balance that never went

down, payments that were applied late, a reduction in their credit

score, errors on their credit report, and a lender that is

uncooperative.

Perhaps regulators and States Attorney’s General should do more.

Perhaps consumers need to be better educated. We anticipate that this

document will help to some degree in opening the subject to further

scrutiny.

Support, additional resources, and final conclusions:

As you prepare test questions, student questions or objectives you can

Amplification of the data contained herein is encouraged, as is the

widest possible dissemination of this document. Please check our

websites for the latest version. Supporting comments and consumer

input relative to Household International and HSBC can be seen at

If you wrote about other companies and want your document included as a

plug-in please let us know.

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