e FEDERAL DEPOSIT INSURANCE CORPORATION, Washington.

DC 20429

SHEILA C. BAIR CHAIRMAN

October 2, 2009

Honorable Barney Frank Chairman

Committee on Financial Services House of Representatives Washington, D.C. 20515

Dear Chairman Frank:

Thank you for your letter regarding specific consumer protection actions and initiatives undertaken by the Federal Deposit Insurance Corporation over the past ten years. I appreciate the opportunity to respond.

As the nation's federal deposit insurer, maintaining consumer confidence and trust in the nation's banking system is a core function. Consumers have confidence in the banking system when banks treat them fairly, and when they can rely on mechanisms both within the industry and those established by government agencies to protect their interests. The FDIC does not consider a bank safe and sound if the bank does not treat its customers fairly. The Deposit Insurance Fund is there to make sure that consumers do not lose their insured deposits, but equally important to consumer confidence is ensuring that consumer protections are enforced on a routine basis, in good times and bad.

It is clear that regulatory gaps in the financial system played a role in exacerbating the current financial crisis. However, the FDIC has continued to take a leadership role in protecting consumers. Whether taking enforcement actions, fostering a dedicated cadre of consumer protection ("compliance") examiners, developing new consumer protection guidance, or serving as a vocal advocate on consumer protection issues, our track record demonstrates that consumer protection at the FDIC has not taken a back seat to any other concerns.

Requesting Additional Consumer Protection Authority

On a number of occasions - most recently in March of this year - in testimony before the House Committee on Financial Services and in the Senate, we have asked for additional rulemaking authority to increase consumer protection (see Attachment A). For example, in June 2007, I said the following before your Committee:

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[R]egulators need to set rules for market participation. Moreover, price competition does not work if consumer~ do not understand the true cost of financial products. Through appropriate rulemaking, regulators can establish consumer protection against abuses that are strong and consistent across industry and regulatory lines. In addition, there should be meaningful enforcement authority and sufficient resources devoted to that authority. To achieve these goals, I would recommend that Congress consider the following reforms:

• The creation of national standards for subprime mortgage lending by all lenders which could be done by statute or through HOEPA rulemaking;

• Expand rulemaking authority to all federal banking regulators to address unfair and deceptive practices; and

• Permit state Attorneys General and supervisory authorities to enforce TILA and the FTC Act against non-bank financial providers ....

The FDIC raised some of the earliest alarms about consumer protection problems adversely affecting both consumers and the economy as a whole. In congressional testimony and speeches, the FDIC raised concerns about the need for stronger consumer protections and highlighted the clear connection between consumer protection and safety and soundness. We urged stronger underwriting standards for nontraditional mortgage products, and argued that they were unsuitable for many borrowers.

In addition, in comments submitted to other financial regulatory agencies, the FDIC has strongly advocated for regulatory changes that would protect consumers and strengthen our financial system (see Attachment B). In comment letters we submitted on proposed rules regarding credit cards, mortgages, and other issues, we requested that the relevant agencies:

• Ban yield spread premiums and allow brokers to be fairly compensated by alternative means;

• Restrict marketing of high fee credit cards to consumers as credit repair products;

• Require banks to only pay overdrafts if consumers have affirmatively selected to participate in overdraft coverage;

• Prohibit underwriting based solely on initial teaser rates for all nontraditional mortgages and ban prepayment penalties outright for higher cost loans; and

• Affirmatively require lenders to consider a borrower's debt-to-income ratio in determining repayment ability.

Enforcing Consumer Protection Laws

Bank examination for consumer compliance has been a long-standing part of our supervisory process. Based on our supervisory and enforcement authority, we mandate corrective action, assess substantial penalties, and require consumer reimbursement when we find violations of law, breaches of fiduciary duty, or mismanagement in banks' consumer protection responsibilities.

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Over the past 10 years, the FDIC has conducted 34,364 consumer compliance and Community Reinvestment Act (CRA) exams and has taken over 1,500 formal and informal enforcement actions to address consumer protection violations or problems (see Attachment C). Enforcement actions generally are based on examination findings, but can also arise through complaints to our Consumer Response Center or third party referrals. For example, in 2008, the FDIC took 182 consumer protection enforcement actions against the banks we supervise. Illustrating the intersection between consumer protection and safety and soundness, some of these enforcement actions jointly addressed safety and soundness and consumer protection problems.

While the FDIC does not have rulemaking authority for unfair or deceptive acts or practices (UDAP), we have been able to aggressively pursue case-by-case enforcement actions that resulted in substantial penalties and restitution to consumers. For example, in four recent significant cases where UDAP violations were found, our enforcement actions resulted in over $165 million in penalties and restitution (see Attachment C). We have taken action relating to credit cards, overdraft protection programs, automatic teller machines (ATM) usage of debit cards, rewards accounts, and other lending practices.' Since 2005, we have cited 75 institutions for violations ofUDAP regarding overdraft lines of credit and overdraft balances.

In 2008, the FDIC and the Federal Trade Commission won a major settlement against CompuCredit, a credit card company, for misleading subprime credit card users. As a result, CompuCredit is correcting its practices and providing $114 million in cash and credits to consumers who were improperly assessed fees as a result of inadequate and misleading disclosures. The FDIC also took groundbreaking enforcement actions against three banks that used this same firm's services. The banks have settled with the FDIC, are correcting their practices, and are substantially improving their compliance management systems and their oversight of third-party service providers. In addition, the FDIC assessed civil money penalties in excess of$5 million (see Attachment C for other examples of significant FDIC enforcement actions).

The FDIC also has consistently ensured that consumers receive restitution when Truth-in-Lending discrepancies such as inaccurate finance charges are found and has achieved those results quickly. Over the last 10 years, we have required more than 900 institutions to make restitution to consumers ranging from a few dollars each to several thousand dollars.

Fair Lending Referrals

We have been, and continue to be, committed to addressing discrimination. In 2001, the FDIC established a Fair Lending Examination Specialist Program with examiners dedicated to providing expert fair lending consultation to compliance examiners. Over the past 10 years, the FDIC has made 213 referrals of pattern or practice

I In March 2007, the FDIC issued additional guidance to its compliance examiners specifically about Overdraft protection programs and accessing balance information through ATMs. and over the phone or internet (see Attachment E).

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fair lending violations to the Department of Justice (DOJ) (see Attachment C). Some of the less significant cases have been referred back to the FDIC for administrative resolution, and we have requested that significant cases involving discriminatory mortgage pricing be referred back to the FDIC in order to speed resolution. For example, at our request, the DOJ returned to the FDIC a case involving First Mariner Bank, and we were able to settle both UDAP and Equal Credit Opportunity Act violations in a $1 million consent order representing $950,000 in restitution to consumers and a $50,000 civil money penalty. We also look for ways to make our consumer protection program more effective, such as by enhancing fair lending examinations through the use of residential pricing data and denial data.

Taking Action Against Third Parties and Coordinating with Other Regulators

In addition to taking action to protect consumers at FDIC-supervised institutions that we have traditionally examined, we use our available authority over institutionaffiliated parties to take enforcement action against third parties. For example, we used this authority against a non-bank credit card company, as described in the CompuCredit example. Where the FDIC does not have enforcement authority over third parties, we have worked with other regulators to ensure that proper enforcement actions are taken. One such example is a 2004 case with Commerce Bank & Trust Company and its affiliate 1-800-East-West Mortgage Company. When an examination of the bank identified significant problems in the entire mortgage process with its affiliate, the FDIC worked with the Division of Banks of the Commonwealth of Massachusetts to issue a joint Cease and Desist Order against the Bank and its affiliate. In this case, we also worked with the Department of Housing and Urban Development to settle RESPA violations involving kickbacks for business referrals. In 2008, the FDIC issued guidance that put banks on notice that they will be held accountable for managing activities conducted through third parties. It also made clear that, under appropriate circumstances, we will use our authority to take action against third parties.

Dedicated Examiner Workforce Focused Exclusively on Consumer Protection

The FDIC has established a robust compliance examination program dedicated to consumer protection. Since 2006, our compliance examination staff has increased by more than 40 percent through a combination of entry level and mid-career, experienced stafTpositions. I want to emphasize that our compliance examiners focus solely on examining banks for consumer protection issues. They are consumer compliance experts by choice and are trained to examine, provide technical assistance on improvements, and cite consumer protection violations. Our 431 consumer compliance examiners have great pride about the work that they do. Their energy and expertise make our consumer protection program effective and strong and they stand ready to enforce the consumer protections laws that Congress puts in place for the future.

Inextricable Relationship Between Consumer Protection and Safety and Soundness

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While our consumer compliance examiners are dedicated to consumer protection supervision, we strengthen our compliance program by having compliance examiners and safety and soundness examiners share information and work together, when appropriate. For example, we have launched Joint Examination Teams (JET teams) where examiners from both consumer compliance and safety and soundness examine institutions offering certain products that are of concern to both disciplines. Through this approach, the FDIC was successful in eliminating payday lending partnerships at FDIC-supervised banks. In addition, JET teams have identified unfair or deceptive acts or practices by third-party vendors pertaining to subprime credit cards.

Between 2005 and 2006, the FDIC investigated over a dozen banks that had partnered with payday lenders. Based on the FDIC's consumer protection and safety and soundness concerns, including a concern about inadequate consideration of the consumer's ability to repay the loans, the FDIC achieved the result that these banks are no longer engaged in these payday loan partnerships. In addition, to monitor future payday lending, the FDIC entered into a written agreement with one of the large payday lenders, which agreed to provide advance notice before entering into a payday lending agreement with an FDIC-supervised bank. We also worked closely with the Department of Defense on its rule to protect service members and their families from payday loans and other problematic credit products.

At the FDIC, compliance examination findings are incorporated into both safety and soundness examinations and Community Reinvestment Act (CRA) performance evaluations. When significant issues are found, especially those relating to discrimination and UDAP, banks' overall composite ratings and their public CRA ratings are directly impacted and often downgraded. In addition, our compliance examination findings have a profound impact on whether or not the FDIC will approve an institution's applications to open additional branches or make other changes to its corporate structure. The failure of a bank to properly handle consumer compliance issues or effectively reinvest in the community is always taken into consideration in the application process along with safety and soundness issues.

The FDIC has long believed that consumer protection and safety and soundness are two sides of the same coin. We do not hesitate in taking appropriate supervisory action to address consumer protection-related violations. Our examination process requires that significant consumer compliance violations are evaluated first at the Regional Office level and then referred to senior officials in Washington, D.C. who focus solely on enforcing consumer protection laws. The Washington consumer compliance office, in conjunction with the Legal Division, reviews the violations and determines the appropriate enforcement actions and corrective measures which may include restitution to consumers.

Responding to Consumer Complaints

In addition to supervising the banking system, the FDIC is an invaluable resource to consumers who are having difficulty dealing with their financial institutions (see

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Attachment G). Since 2005, the FDIC's Consumer Response Center has received more than 100,000 complaints and questions from consumers about consumer protection matters. The FDIC has been instrumental in helping these individuals resolve their banking issues.

Beyond assisting consumers, our Consumer Response Center is an integral part of the examination process. One of the first things that an examiner does to prepare for a consumer compliance exam is to review consumer complaints. The Center provides examiners a report outlining complaints received against particular banks. When a potential violation or other supervisory concern is identified, the Consumer Response Center works closely with the examination function to assure appropriate follow-up action is taken.

As an example, earlier this year, the FDIC resolved significant issues arising out of complaints from consumers whose credit card convenience checks were not honored by the issuing bank. We required the bank to improve its process for determining customer eligibility for convenience checks and to ensure that the checks are honored consistently with the bank's consumer disclosures. The bank paid a $250,000 Civil Money Penalty for this unfair practice and refunded $160 per dishonored check to an estimated 10,000 affected customers.

Vocal Advocate and Thought Leader for Consumer Protection

I am proud of the leadership role that the FDIC has taken in the consumer protection arena. By encouraging banks to offer responsible products, conducting research on emerging consumer protection issues, and bringing together leaders to foster economic inclusion for all Americans, the FDIC seeks to protect consumers and to empower them to make best use of the American financial system.

Foreclosure Prevention and Loan Modifications

When the housing market was devastated by foreclosures, early on we advocated for long-term sustainable foreclosure prevention programs. Our experience managing foreclosures at IndyMac Bank led us to develop an effective loan modification protocol which served as the model for the Administration's Joan modification program. We also designed the "Mod In a Box" which we placed on our website to give all lenders the ability to create streamlined and sustainable loan modifications in an effort to address the growing number of foreclosures throughout the United States.

Small Dollar Loan Program

Through our small-dollar loan pilot program, we have encouraged banks to offer affordable alternatives to high cost payday loans. The pilot is a two year case study designed to identify and amplify models for banks to offer affordable and profitable small dollar loans. After six quarters of results, the 31 banks in the pilot have made nearly 24,000 loans with a balance of more than $28 million. Interestingly, loans made by

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banks in the pilot are no more likely to default than loans to the general population, and participating bankers report that the loans represent an important cornerstone for profitability.

Financial Literacy

Since 2001, the FDIC's award-winning Money Smart financial education program has helped participants enhance their money management skills by leaming the benefits of saving money, effectively managing credit, and avoiding predatory financial practices. Money Smart is available in seven languages and has reached more than 2.4 million individuals. Findings from a longitudinal survey of consumers show that Money Smart can positively influence how people manage their finances, as those who took the Money Smart course were more likely to open deposit accounts. save money, use and adhere to a budget, and have increased confidence in their financial abilities when contacted 6 to 12 months after completing the course.

Overdraft Study

Because little data was available regarding overdraft protection programs, we began a study in 2006 and, in November 2008, we issued our "FDIC Study of Bank Overdraft Programs." This was a two-part study that gathered empirical data on the types, characteristics, and use of overdraft programs operated by FDIC-supervised banks. Our objective was to provide data that would assist policymakers and inform the public of the features and costs related to overdraft programs.

Economic Inclusion

The FDIC's Advisory Committee on Economic Inclusion (ComE-IN) was formed in 2006 to provide advice and recommendations to the FDIC in improving access to the financial mainstream for the 10 million unbanked households and the millions more underbanked households that use alternative financial service providers. often at a very high cost. The Committee is comprised of a diverse mix of academics, bankers, consumer advocates, and government officials to ensure a wide range of views. To date, this Committee has tackled some of the most challenging issues facing underserved consumers, including subprime mortgages and foreclosure prevention, asset building and prize-linked savings strategies. and access to affordable small dollar credit. Advice provided by this Committee has helped shape many aspects of the FDIC's response to issues facing consumers, including the use ofCRA ratings and other incentives for banks to provide better access to the financial mainstream, increasing consumer-focused research, and conducting our pilot program for banks offering small dollar loans.

In addition, the Alliance of Economic Inclusion (AEI) was created in June 2006 to work with financial institutions and other partners to bring those currently unbanked and underserved into the financial mainstream. The AEI focuses on expanding banking services in underserved markets, including low- and moderate-income neighborhoods, minority communities and rural areas.

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Access to Mortgage Credit

In July 2008, the FDIC hosted a forum to discuss potential solutions to the serious disruption in mortgage credit access that occurred as a result of the burgeoning economic crisis. We convened a distinguished set of experts, including the Secretary of the Treasury, the Chairman of the Federal Reserve, bank CEOs, rating agency officials, investors, academics, and others to discuss how the market for low- and moderate-income (LMI) mortgages could be rejuvenated. As a result of this forum, we issued best practices for lending to LMI consumers for banks and others. Among other findings, these best practices addressed the importance of strong due diligence, mitigating moral hazard or having "skin" in the game, and aligning compensation related to mortgage transactions with loan performance.

Leveraging CRA for Consumer Protection

The FDIC has had a strong commitment to the statutory objectives of the CRAto expand credit to low- and moderate-income communities and address redlining. Our dedication to CRA is demonstrated through our examination program and the guidance we have issued to banks and examiners. The FDIC's compliance examiners conduct CRA examinations in conjunction with our consumer compliance examinations, which include a strong fair lending component.

As a matter of policy, we emphasize to our examination force that bank. CRA ratings must reflect full consideration of consumer protection violations and any discriminatory practices in CRA ratings. As a result, we have consistently linked our rigorous fair lending oversight and UDAP enforcement initiatives to CRA ratings of institutions. Recent examples ofCRA downgrades resulting from our consideration of these violations include Columbus Bank and Trust, Republic Bank, and Advanta (see Attachment C).

The FDIC has shown leadership by leveraging CRA to encourage solutions to emerging consumer and community credit needs. For example, in June 2007, we issued guidance (Financial Institution Letter 50-2007) to encourage financial institutions to offer small-dollar credit products and to promote these products to their customers. The guidance informed banks that such loans would be considered favorably under the CRA if they were affordable, safe and sound, consistent with all applicable federal and state laws. and served low- and moderate-income customers.

As you know, we were early advocates for considering loan modification and foreclosure prevention initiatives more fully in CRA evaluations. The focus on effective loan modifications continues to require strong industry encouragement and practical tools for implementation, such as our FDIC foreclosure prevention tool kit, updated on September 16,2009.

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In addition, we have taken a leadership role in working with the other Federal regulators to promote additional interagency guidance to ensure that financial institution responses to these two emerging issues are fully considered during CRA examinations. Guidance on favorable consideration ofsmallloans and loan modifications, for example, has been incorporated into Interagency Questions and Answers.

The FDIC also continues to explore using positive CRA consideration as an incentive for banks to offer products that build wealth and provide for financial security. The FDIC has pursued new initiatives to promote broader access to banking services by traditionally underserved populations and to ensure adequate consumer protection in the provision of these services, including conducting significant surveys and forums on serving the unbanked.

Conclusion

We believe that our record demonstrates our deep commitment to consumer protection. With the advent of the Consumer Financial Protection Agency (CFPA) and the prospect of strong rules applicable to all consumer financial providers, services and products, the FDIC is eager to leverage our dedicated, experienced compliance examination and enforcement staff and other resources to support the CFP A's consumer protection mission.

The enclosed attachments provide more detailed information that we hope is helpful to you. Please let me know if you have questions or need additional information.

Sincerely,

Sheila C. Bair

Enclosures:

Attachment A - FDIC requests for new or enhanced authorities Attachment B - FDIC comment letters on proposed regulations Attachment C - Formal and informal enforcement actions Attachment D - Final rules

Attachment E - New/revised examination procedures (CD also provided) Attachment F - Formal guidance and policies (financial institution letters) Attachment G - Consumer complaint program

Attachment H - Consumer outreach and financial education Attachment I - Reviews, audits, and assessments

Attachment A

Requests for Additional Authority to Protect Consumers:

Testimony Before Congress and Related Correspondence

March 20, 2009

Testimony by Martin C. Gruenberg, Vice Chairman, Federal Deposit Insurance Corporation "Federal and State Enforcement of Consumer and Investor Protection Laws" before the House Committee on Financial Services

Pages 16 through 18

Excerpt:

In order to further strengthen the use of the FTC Act's rulemaking provisions, the FDIC has recommended that Congress consider granting Section 5 rulemaking authority to all federal banking regulators. By limiting FTC rulemaking authority to the FRB, OTS and NCUA, current law excludes partlctpation by the primary federal supervisors of about 7,000 banks. The FDIC's perspective -- as deposit insurer and as supervisor for the largest number of banks, many of wbom are small community banks -- would provide valuable input and expertise to tbe rulemaking process. [page 17J

March 19,2009

Testimony by Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation "Modernizing Bank Supervision and Regulation" before the Senate Committee on Banking, Housing and Urban Affairs

Excerpts:

Under tbe Federal Trade Commission (FTC) Act, only the Federal Reserve Board bas autbority to issue regulations applicable to banks regarding unfair or deceptive acts or practices ... the FTC Act does not give tbe FDIC autbority to write rules that apply to the approximately 5,000 entities it supervises - tbe bulk of state banks-nor to tbe OCC for their 1700 national banks ... [lJn order to strengthen tbe use of tbe FTC Act's rulemaking provisions, tbe FDIC has recommended that Congress consider granting Section 5 rulemaking autbority to all federal banking

regulators ... tbe FDIC's perspective - as deposit insurer and as supervisor for tbe largest number of banks, many of whom are small community banks -- would provide valuable input and expertise to the rulemaking process.

April 17, 2008

Testimony by Martin C. Gruenberg, Vice Chairman, Federal Deposit Insurance Corporation "The Credit Cardholders' Bill of Rights: Providing New Protections for Consumers" before the House Committee on Financial Services

Pages 8 through 10

Excerpts:

While improved disclosures are important, it is doubtful whether even improved disclosures can mitigate the harmful effect of some of the most questionable

practices. Action by Congress may expedite solutions to some of the most troubling practices. [page 8]

********

Last year, the House of Representatives passed legislation, H.R. 3526, to amend the FTC Act to grant banking agency the authority to prescribe regulations governing unfair or deceptive acts or practices with respect to the institutions each such agency supervises. The authority in H.R. 3526 would be a helpful addition to our present enforcement authority, and would enable us to improve our ability to address egregious and pervasive practices on an industry-wide basis. Including the perspectives ofthe supervisor of some ofthe nation's largest banks and the perspectives of the supervisor of the largest number of banks as well as the deposit insurer would provide valuable input and expertise to the rulemaking process. [page 9]

Response to follow-up questions from Rep. Barrett (May 5, 2008 letter to Chairman Frank) [attached]

April 15,2008

Robert W. Mooney, Deputy Director, Division of Supervision and Consumer Protection, Federal Deposit Insurance Corporation

"Financial Literacy and Education: The Effectiveness of Governmental and Private Sector Initiatives"

Pages 2 through 3 Excerpt:

The FDIC has called for national standards to address many of the problems and abuses that are now coming to light in the subprime mortgage market. These standards should impose underwriting based on the borrower's ability to repay the true cost of the loan, especially among the non-bank lenders currently operating with little or no regulatory oversight. Such standards also should address misleading or confusing marketing that prevents borrowers from properly evaluating loan products. [page 2]

April 9, 2008

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation "Using FHA for Housing Stabilization and Homeownership Retention" Page 6

Excerpt:

I would emphasize tbat tbere is a particular urgency for Congress to act on legislation to establisb national licensing standards for non-bank mortgage participants. [page 6]

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February 13, 2008

Sandra L. Thompson, Director, Division of Supervision and Consumer Protection, Federal Deposit Insurance Corporation "The Community Reinvestment Act: Thirty Years of Accomplishments, But Challenges Remain" before the House Financial Services Committee. Excerpt:

These patterns raise questions about what should constitute a bank's assessment area and whether only lending within tbe assessment area sbould be considered. They also raise questions about whether continuing to cover only banks and tbrifts under CRA is achieving the goals establisbed by CRA thirty years ago - that is, to work towards meeting the credit needs of entire communities. [page 23]

December 6, 2007

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation "Accelerating Loan Modifications, Improving foreclosure Prevention and Enhancing Enforcement" before the House Financial Services Committee

Excerpts:

" Between now and the end of 2008, subprime hybrid ARMs representing hundreds of billions of dollars in outstanding mortgage debt will undergo payment

resets ... these foreclosures will inflict financial barm on individual borrowers and their communities ... the FDIC advocates a systematic approach to loan restructuring."

October 24, 2007

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation

"Legislative Proposals on Reforming Mortgage Practices" before House Financial Services Committee

Pages 3 through 4 Excerpt:

Legislative action by tbis Committee and rulemaking by the Federal Reserve Board under the Horne Ownersbip and Equity Protection Act (HOEPA) hold out promise that mortgage originations will return to the standards and fundamentals that have served us well for many years.

In my June testimony before tbis Committee, I listed several elements that should be included in national standards for mortgage lending. [page 3]

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September 5, 2007

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation, "Recent Events in the Credit and Mortgage Markets and Possible Implications for U.S. Consumers" before the House Financial Services Committee

Excerpt:

The FDIC "supports the exercise of authority by the Federal Reserve under HOEPA to establish a national standard."

June 13, 2007

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation "Improving Federal Consumer Protection in Financial Services" Pages 9 through 10, 17 through 28

Excerpts:

Through appropriate rulemaking, regulators can establish consumer protections against abuses that are strong and consistent across industry and regulatory lines. In addition, there should be meaningful enforcement authority and sufficient resources devoted to that authority. To achieve these goals, I would recommend that Congress consider the following reforms:

• The creation of national standards for subprime mortgage lending by aJllenders which could be done by statute or through HOEPA rulemaking;

• Expand rulemaking authority to all federal banking regulators to address unfair and deceptive practices; ••• (page 17]

Response to follow-up questions from Rep. Waters (July 20,2007 letter to Ms. Waters): [attached]

June 7, 2007

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation

"Improving Credit Card Consumer Protection: Recent Industry and Regulatory Initiatives" Pages 7, 9 through 10, 21

Excerpt:

The Federal Reserve Board has the authority to promulgate regulations defining unfair and deceptive acts or practices of banks, while the Office of Thrift Supervision and the National Credit Union Administration enjoy similar rulemaking authority for thrift institutions and credit unions, respectively. Other Federal banking agencies, including the FDIC, may use their enforcement authority pursuant to the FDI Act to address unfair and deceptive acts and practices engaged in by their supervised institutions, but they have no rulemaking authority. [page 9- 10]

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September 23. 2()()l)

lilt: Honorable Sheila C. Hair CII;lirlll,lll

h:(iL'rall)q)():;il Iusurancc Corporation .'i:;U 1/' ,';U\,'d, N'vV'

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RL: COI1SIIll1Cr Protection Iniuauves

DIII'ill!', the COIII':;-: of 'I he ddlale n:galding lile Consumer l;il)allci;;ill),'otc\~li()Jl /\gl.'11CV

( '1'1) A) two main ilrgllf11L:llts ilavL' been made by federal )'~'glll;ll()rS and many in iudustrv ")!,;Iill~;t Ille cl'Jllnili/alioll OfCOIl:-iU111l;r protcctiou functions. '.Ve are told thai the federal agL'IIl:ic:; du Illil 11';1111 10 lose their CLJIlSUJ)J\"r protection authority because that authority is iutcgrully linked with L'\,;du~)til1.'_~;111 institutiou'« overall sa!"..'ly and soundness, We arc also tult! lil,)t Illl: l'cdcr:d ;I_!!:\'llci,'s ;lle nut only capable oL but willing 10, lake acuon to protect C()I1SII111L:r,;.

Tile lirs: arglllllclll ignores the fact that in troubled limes, a regulator tnskcd wirl: s:dt:ty and soundness responsibilities ([1/(/ COl1SUllIl!l' protection rcsponsihiluics wi il alJlWSI CLT1:1iIJiy locus its efforts 011 the former at the expense of tile lutter. ami consumers will suiTer. Imkctl,ll:ld more focus been placed on consumer protection Iuncrions earlier in this decade, much otthe current crisis Il1i1Y well have been avoided.

The second argument is ofparticular interest to 111,111)' o lmy colleagues und me. It would :~I'cally inform the debate over the CFPA ifmy colleagues and I had a better understanding o lthc .';pccllil· consumer protection actions your "genC'y has undertaken durillg the last [(J years, III particular, please idcntilv allY I~ nal rilles or regular ions adopted, forma I ell (t)!'CL',lllt:111 ;Jet iOIl,; tuken (including written ,1!',rcl;l11enl,; and cease and desist orders), informal en 1<)fCClllc'/l I :)cliOIlS taken lillcllldil1,', hO<1rd resolutions adopted and ,vl0Us entered il1I0), new inxpecrion protocols or procedures adopted. Ii.lrmai policies adopted or regulatory guidance issued, ()I :lIlY other actions taken by your "gcllc), that related directly to consumer protection functions, Additionally, 10 the extent you have undertaken any reviews, audits, or assessments ot elJ1Y Dr these initiatives, pk:1S~' provide a :;,1I111111:11')' of tile results. To tile extent your agency sought to take ;ldditillll;ll actions but 1(luml it did 110t have the authority to do so. please idcuti ly what specific new authorities you Iupil'sted of Cllll,~::',rcs~;.

As you know, we arc Oil a very short tirnefrarnc, but this informarion is l)f'grt~;11 11111)(.m:1I1l·'.~ 10 the Committee. YOIli' responses arc appreciated hy Friday. October 1,200').

"y;~ "

.~~~, .. '.. ~

(~;~Y/I;~ANK'

. '~,i!t

Chuirmnn->

e FEDERAL DEPOSIT INSURANCE CORPORATION, Washington, DC 20429

SHEILA C. BAIA CHAIRMAN

September 9,2009

Honorable Spencer Bachus Ranking Minority Member Committee on Financial Services House of Representatives Washington, D.C. 20515

Dear Congressman Bachus:

Thank you for the opportunity to respond to the questions you submitted subsequent to my testimony at the hearing on "Regulatory Perspectives on the Obama Administration's Financial Regulatory Reform Proposals-Part II," before the House Financial Services Committee on July 24,2009.

Enclosed are my responses. If you have further questions or comments, please do not hesitate to contact me at (202) 898-6974 or Paul Nash, Deputy for External Affairs, at (202) 898-6962.

Sincerely,

Sheila C. Bair

Enclosure

Response to questions from the Honorable Spencer Bachus by Sheila C. Bair, Chairman,

Federal Deposit Insurance Corporation

UDAP Questions

Q1. Under the Federal Trade Commission Act, only the Board of Governors of the Federal Reserve System (Fed) has the authority to issue rules or regulations defining what acts or practices are unfair or deceptive with respect to all banks, including those for which the FDIC or the OCC is the primary federal regulator. Neither the FDIC nor the OCC has authority to adopt such rules or regulations for the banks they regulate. The Fed, FDIC and OCC, however, have taken the position that the FDIC and the OCC may define what acts or practices they think are unfair or deceptive on a case-by-case basis in the context of administrative enforcement proceedings, and the FDIC has done just that, as reflected in a series of Consent Cease and Desist Orders recently issued by the FDIC including those regarding Advanta Bank Corporation; American Express Centurion Bank of Salt Lake City, Utah; and the CompuCredit-related cease and desist orders against Columbus Bank and Trust, Columbus, Georgia, First Bank of Delaware, Wilmington, Delaware, and First Bank & Trust, Brookings, South Dakota.

Qla. The FTC Act expJicitly confers upon the Federal Reserve Board, the Federal Home Loan Bank Board, and the National Credit Union Administration Board the authority to "define with specificity" unfair and deceptive acts and practices. While the FTC Act grants enforcement authority to the FDIC and OCC, the Act does not explicitly grant the FDIC and OCC the authority to define unfair or deceptive acts and practices. In other words, under the express language of the FTC Act, the FDIC and the OCC do not have the statutory authority to decide for the banks they regulate that a particular act or practice is unsafe or unsound, either by adopting a regulation or on a case-by-case basis in enforcement proceedings.

Qla(i). Have the FDIC and the OCC each analyzed this legal issue and prepared written legal opinions which conclude that they eacb do have the authority to define unfair or deceptive acts or practices on a case by case basis?

Ala(i): The FDIC General Counsel has not issued a fonnallegal opinion, but the FDIC has issued two Financial Institution Letters (FILs) addressing this issue, "Guidance on Unfair or Deceptive Acts," FIL-S7-2002 (May 30,2002), and "Unfair or Deceptive Acts or Practices by State-Chartered Banks," FIL-26-2004 (March 11, 2004). Copies of the two FILS are attached.

The FTC Act contains a broad prohibition on the use of unfair or deceptive acts or practices that does not depend on specific regulations. The FTC Act also grants authority to the FTC and to certain financial regulators including the Fed (for banks), the Office of Thrift Supervision (for thrifts), and the National Credit Union Administration (for credit

unions) to issue regulations with respect to specific practices. Insured financial institutions must comply with both the general prohibition on the use of unfair or deceptive practices and any regulations issued by the appropriate financial regulator. If an insured financial institution violates the FTC Act or an implementing regulation, the banking agencies can pursue corrective actions including enforcement actions such as cease and desist orders and the imposition of civil money penalties under Section 8 of the Federal Deposit Insurance Act (FDI Act). For example, in the Compucredit cases listed above, the FDIC brought actions against the three banks, and the FDIC and FTC brought parallel actions against Compucredit.

Qla(ii). Have these opinions been reviewed and approved by the General Counsel of each agency?

Ala(ii). The FDIC General Counsel reviewed the issue and approved the two FILS before their issuance.

Ql a(iii). Has the Fed General Counsel's office reviewed these opinions or performed its own analysis and prepared its own written opinion?

Ata(iii). While the FDIC is not aware of a formal written opinion by the Fed's General Counsel addressing the FDIC and the OCC's authority to cite banks for violations of Section 5 and take appropriate enforcement action, the Fed has publicly stated this position. Then Chairman Greenspan in his May 30,2002 letter to Honorable John J. LaFalce, Ranking Member, Committee on Financial Services, noted that "the banking agencies also may take formal enforcement actions under the FDI Act to prevent unfair or deceptive practices that violate the FTC Act." Further, the Fed and the FDIC jointly issued FIL-26-2004, "Unfair or Deceptive Acts or Practices by State-Chartered Banks," which explicitly stated the authority to take enforcement actions under Section 8 of the FDl Act against banks that commit unfair or deceptive trade practices, as provided in Section 5. The Fed, along with the OTS and the NCUA, recently reaffirmed the authority to enforce Section 5 on a case-by-case basis in the Preamble to the January 29, 2009, Amendments to Regulation AA, 74 FR 5498.

Qla(iv). Have any of the opinions that may have been prepared by the FDIC, OCC, and/or the Fed regarding this issue been reviewed by any independent third party, such as the relevant Inspectors General or the Justice Department?

At a(iv). We are not aware that either FIL has been reviewed by the FDIC Inspector General or the Justice Department. In Roberts v. Fleet Bank (R.I.), 342 F. 3d 260,269- 70 (Jrd Cir. 2003), the Court of Appeals recognized that the ace has the authority under Section 8 to address proscribed conduct under Section 5.

Qb. What, if any procedures have been established to assure that the Fed, OCC, and the FDIC are all in agreement as to what acts or practices are unfair or deceptive?

Ab: When the FDIC first considered whether it would be appropriate to enforce the FTC Act's Section 5 prohibition against unfair and deceptive acts and practices on a case-bycase basis, it consulted with the Fed. The two agencies determined that such enforcement would be appropriate under Section 8 of the FDI Act. As a means to ensure consistency, they also agreed to follow the standards developed by the FTC and tested through the courts. In FIL 26-2004, the FDIC and the Fed jointly explained that they would follow those standards, which were described in the FIL, and that they would "also consider factually similar cases brought by the FTC and other agencies to ensure that these standards are applied consistently."

The FDIC subjects all potential UDAP cases to a thorough internal review, by both examination and legal staff at multiple levels, which considers the unique facts and circumstances of that case. Each case is considered individually, because a change in a single fact can make the difference between finding a UDAP violation or not.

The FDIC staff regularly consults with FTC staff to obtain informal views in particular situations. The FDIC and Fed staffs are in regular contact through mechanisms such as the FFIEC Consumer Compliance Task Force and other less formal means of communication. A Consumer Compliance Task Force working group has been drafting UDAP examination procedures, for example.

Qb(i). How do the regulators ensure that the OCC and/or the FDIC do not adopt a UDAP rule in a case through their respective adjudicatory processes that has not been, or is not, also adopted by the other banking agencies? Do you see a problem with the possibility of inconsistent rulings or positions between or among the federal banking agencies regarding what acts or practices are unfair or deceptive?

Ab(i). When the FDIC brings an enforcement action against a bank for unfair or deceptive practices on a case-by case basis, the agency has not promulgated a UDAP rule under the FTC Act. As the agencies follow the standards established by the FTC and consult with that agency, we do not believe the agencies will enforce Section 5 in an inconsistent manner. In addition, final decisions by the FDIC in enforcement cases are subject to review by United States Courts of Appeal.

Qb(ii). Are you aware of any inconsistent positions that exist as of today, i.e. situations where the FDIC or OCC or Fed has determined in the context of an administrative enforcement proceeding that a particular act or practice is unfair or deceptive, while one or both of the other agencies have not and do not regard the conduct at issue as a violation of the FTC Act? How would you find out if that was the case?

Ab(ii): We are unaware of any inconsistent positions taken by the agencies in administrative enforcement proceedings addressing unfair or deceptive acts or practices. Further before the FDIC brings a significant formal enforcement action against an institution in a UDAP matter, such as to impose a cease and desist order, restitution order, or a civil money penalty, in most instances the action is approved by the FDIC Case Review Committee, which includes OCC and OTS representatives as voting members. Agency staff routinely discusses matters such as these at Consumer Compliance Task Force meetings.

Questions on FAS 166 and FAS 167

Q1. What will be the impact of this "consolidation" on bond investors who are critical to the extension of credit and the future of our securitized credit markets?

A 1. The securitization market involves the complex interaction of originators, borrowers, servicers, and investors. While securitization has helped to extend credit and increase funding of housing and other important markets, the recent crisis has exposed some deficiencies that are in the process of being addressed. The impact of the Financial Accounting Standards Board's (FASB) new accounting standards that will require the consolidation of certain off-balance sheet structures along with other recent reform efforts, such as the requirement for securitizers to retain a percentage of the credit risk on any asset that is transferred through a securitization, is difficult to predict. The various initiatives change the incentives, risks, and rewards for the various securitization market participants in different ways that make it difficult to predict the overall market impact.

The FDIC along with the other banking agencies has just issued a Notice of Proposed Rulemaking (NPR) related to the FASB's adoption ofFAS 166 and FAS 167. The NPR seeks to better align regulatory capital requirements with the actual risks of certain exposures and seeks comment and supporting data on the impact of the accounting changes on securitization activity, lending, and financial markets generally. It also seeks comment and supporting data on the features and characteristics of transactions that, although consolidated under the new accounting standards, might merit an alternative capi tal treatment, as well as on the potential impact of the new accounting standards on lending, provisioning, and other activities.

Q2(a) Does the FDIC consult with the other federal banking agencies in an effort to achieve uniformity with respect to the factors that will be evaluated and the standards that will be applied in arriving at such individual capital requirements for institutions?

A2(a): The federal banking agencies work together to achieve uniformity in the development, interpretation, and implementation of the risk-based capital requirements. An interagency capital policy group from the supervision and legal divisions of the respective agencies meets regularly to discuss and reach consensus on capital policy

issues involving new interpretations of the agencies capital rules. We note, for example, that the FDIC and the other federal banking agencies have just developed a uniform joint NPR for a regulatory capital rule to address F AS 166 and F AS 167.

Q2(b): Should the federal banking agencies apply the same criteria to determine the capital ratios for a regulated institution?

A2(b): Insured depository institutions are subject to regulatory capital standards that are, with rare and very minor exceptions, identical across the federal banking agencies. Supervisors generally expect banks to hold capital in excess of regulatory minimums commensurate with their risk profiles. It is appropriate for the agencies to look to a common set of factors in determining capital adequacy, including the individual risk profile of the institution, the level and severity of adversely classified assets, and the institution's interest rate risk.

Q2(c): Is there consistency between and among the federal banking agencies regarding the criteria they use to determine whether to establish individual capital requirements?

A2(c): As provided in the response to question 2(b) above, the agencies generally evaluate a common set of factors in determining whether, and to what extent, an institution should be required to hold capital in excess of the regulatory minimums. However, this determination is dictated largely by the circumstances of the individual institution and supervisory judgment by the respective agencies, including under the specific delegations of authority under the capital rules involving the appropriate classification of capital instruments and the proper risk-weighting of assets under the risk-based capital rules.

Q2(d): Does your agency use an economic model to determine the capital ratios a given institution should maintain in light of its particular risk profile in order to be considered adequately capitalized or well-capitalized?

ii. If you do use a model, whose model is it?

1. Was it constructed by your agency alone?

2. Did you discuss it with the other banking agencies, or consult with them regarding what, if any, models they use for such purposes?

3. To the extent you know what differences there are between any model that your agency uses and any model used by any other banking agency, how do you go about resolving hose differences, if at all?

4. Do you have a set of standards you use in evaluating capital adequacy models that are employed by the institutions you regulate and, if so, what are they and were they developed in consultation with any other agencies?

A2(d): No, the FDIC does not use an economic model in determining the capital ratios an institution should maintain. In December 2007, the banking agencies promulgated a regulation mandating the use of certain "advanced approaches" from Basel II to calculate regulatory capital for large, complex banks. These approaches draw heavily from banks' own internal risk models. No U.S. bank is currently calculating its capital requirements under these approaches.

The agencies expect the internal capital adequacy assessment of any institution to go beyond the assumptions underlying the minimum risk-based capital requirements. Although the assessment process may vary on an institution-by-institution basis, banks may use economic capital measures for certain elements of risk management, such as limit setting or for evaluating performance and aggregate capital needs. However, notwithstanding the particular metrics or analytical paradigm used for any given process, the fundamental objectives ofthe internal assessment must remain the same: to identify and measure material risks; set and assess internal capital adequacy objectives that relate directly to risk; and ensure the integrity of internal capital adequacy assessments. The interagency guidance document discusses the agencies' expectations with respect to each of these objectives, with a specific emphasis on the various risk types that should be identified and measured as part of the internal capital adequacy assessment process (i.e., credit, market, operational, interest rate, and liquidity risk).

FDIC: FIL-57-2002: Guidance on Unfair or Deceptive Acts or Practices

Horne > News & Events > Financial Institution letters

Financial Institution Letters

GUIDANCE ON UNFAIR OR DECEPTIVE ACTS OR PRACTICES

FI L-57 -2002 May 30, 2002

TO CHIEF EXECUTIVE OFFICER

SUBJECT: Unfair or Deceptive Acts or Practices:

Applicability of the Federal Trade Commission Act

The Federal Trade Commission Act (FTC Act) declares that unfair or deceptive trade practices are illegal. See 15 USC § 45(a) (FTC Act Section 5). This letter confirms that the Federal Deposit Insurance Corporation (FDIC) intends to cite state nonmember banks and their institution-affiliated parties for violations of FTC Act Section 5 and will take appropriate action pursuant to its authority under Section 8 of the Federal Deposit Insurance Act (FDI Act) when unfair or deceptive trade practices are discovered. FDIC enforcement action against entities other than banks will be coordinated with the Federal Trade Commission, which also has authority to take action against nonbank parties that engage in unfair or deceptive trade practices.

In order to determine whether a practice is "unfair," the FDIC will consider whether the practice "causes or is likely to cause substantial injury to consumers which is not reasonably avoided by consumers themselves and not outweighed by countervailing benefits to consumers or to competition." 15 U.S.C. § 45(n). By adhering to this tenet. the FDIC will take action to address conduct that falls well below the high standards of business practice expected of most banks and the parties affiliated with them.

In addition, to correct deceptive trade practices, the FDIC will take action against representations, omissions, or practices that are likely to mislead consumers acting reasonably under the circumstances, and are likely to cause such consumers harm. The FDIC will focus on material misrepresentations, i.e., those that affect choices made by consumers because such misrepresentations are most likely to cause consumers financial harm.

The FDIC recognizes that the institutions that it supervises generally adhere to high standards of conduct. The agency, therefore, anticipates that it will not be required to take action to correct unfair or deceptive practices on a frequent basis. However, to avoid misunderstanding about the applicability of the FTC Act, this letter is intended to clarify that the FTC Act's prohibition against unfair and deceptive trade practices does apply to your institution, and to its subsidiaries and third-party contractors.

VVhile the Federal Trade Commission has adopted policy statements on unfairness (FTC Policy Statement on Unfairness, December 17, 1980) and deception (FTC Policy Statement on Deception, October 14. 1983), most unfair and deceptive trade practices have been defined in fact-specific, caseby-case adjudications. The FDIC anticipates that additional guidance will be provided in similar fashion going forward.

Please contact Division of Compliance and Consumer Affairs (DCA) staff in your regional office for more information. To obtain Federal Trade Commission business guidance on unfair and deceptive practices and other topics, please link to: www.ftc.gov/ftc/business.htm. For assistance from the DCA Washington Office, please call April Breslaw, Senior Policy Analyst, at (202) 942-3061, Louise Kotoshirodo Kramer, Policy Analyst, at (202) 942-3599, or David LaFleur, Policy Analyst. at (202) 942- 3466.

Michael J. Zamorski Director

Distribution: FDIC-Supervised Banks (Commercial and Savings)

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NOTE: Paper copies of FDIC financial institution letters may be obtained through the FDIC's Public Information Center, 801 17th Street. NW, Room 100, Washington, DC 20434 (800-276-6003 or (703) 562-2200).

Last Updated 0513012002

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Horne> News & Events > Financial Institution Letters

Financial Institution Letters

Unfair or Deceptive Acts or Practices by State-Chartered Banks

FI L-26-2004 March 11, 2004

TO SUBJECT:

CHIEF EXECUTIVE OFFICER (also of interest to Compliance Officer) Unfair or Deceptive Acts or Practices Under Section 5 of the Federal Trade Commission Act

The FDIC and the Board of Governors of the Federal Reserve System are issuing quioence to state-chartered banks to outline the standards that the agencies will consider when applying the prohibitions against unfair or deceptive acts or practices found in section 5 of the Federal Trade Commission Act. The guidance also provides information about managing risks relating to unfair or deceptive acts or practices, including best practices.

Summary:

The Federal Deposit Insurance Corporation (FDIC) and the Board of Governors of the Federal Reserve System are jointly issuing the attached guidance to state-chartered banks regarding unfair or deceptive acts or practices prohibited by section 5 of the Federal Trade Commission (FTC) Act.

In FIL-57-2002, issued May 30, 2002, the FDIC informed state nonmember banks that these

prohibitions apply to their activities, and that the FDIC would issue guidance about how institutions could avoid engaging in practices that might be viewed as unfair or deceptive. In its corresponding release,

the Federal Reserve Board indicated that it would work with the FDIC to prepare additional guidance for state member banks on this subject. The attached guidance fulfills these commitments.

Specifically, the guidance explains:

• the standards used to assess whether an act or practice is unfair or deceptive;

• the interplay between the FTC Act and other consumer protection statutes; and

• guidelines for managing risks related to unfair and deceptive practices.

Although most insured banks adhere to high levels of professional conduct, managers of all banks must remain vigilant against possible unfair or deceptive acts or practices to protect consumers and to minimize their own risk.

For more information about the guidance, please contact April P. Breslaw, Section Chief (202- 898- 6609); Deirdre Foley, Senior Policy Analyst (202-898-6612); or Mira N Marshall, Senior Policy Analyst (202-898-3912), in the Division of Supervision and Consumer Protection.

For your reference, FDIC Financial Institution Letters (FILs) may be accessed from the FDIC's Web site at www.fdlcgov/news/news/financiaIl2004/index.html.

Michael J. Zamorski Director

Division of Supervision and Consumer Protection

###

Attachment: Unfair or Deceptive Acts or Practices by State-Chartered Banks March 11, 2004

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Distribution: FDIC-Supervised Banks (Commercial and Savings)

NOTE: Paper copies of FDIC financial institution letters may be obtained through the FDIC's Public Information Center, 80117 th Street, NW, Room 100, Washington. DC 20434 (1-877-275-3342 or (703) 562-2200).

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Horne> News & Events> Financial Institution Letters

Financial Institution Letters

Board of Governors of the Federal Reserve System Federal Deposit Insurance Corporation

Unfair or Deceptive Acts or Practices by State-Chartered Banks March 11,2004

Purpose

The Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (the "Board" and the "FDIC," or collectively, the "Agencies") are issuing this statement to outline the standards that will be considered by the Agencies as they carry out their responsibility to enforce the prohibitions against unfair or deceptive trade practices found in section 5 of the Federal Trade Commission Act ("FTC Act") as they apply to acts and practices of state-chartered banks. The Agencies will apply these standards when weighing the need to take supervisory and enforcement actions and when seeking to ensure that unfair or deceptive practices do not recur.

This statement also contains a section on managing risks relating to unfair or deceptive acts or practices, which includes best practices as well as general guidance on measures that state-chartered banks can take to avoid engaging in such acts or practices.

Although the majority of insured banks adhere to a high level of professional conduct, banks must remain viqilant against possible unfair or deceptive acts or practices both to protect consumers and to minimize their own risks.

Coordination of Enforcement Efforts

Section 5(a) of the FTC Act prohibits "unfair or deceptive acts or practices in or affecting commerce," and applies to all persons engaged in commerce, including banks. The Agencies each have affirmed their authority under section 8 of the Federal Deposit Insurance Act to take appropriate action when unfair or deceptive acts or practices are discovered

A number of agencies have authority to combat unfair or deceptive acts or practices. For example, the FTC has broad authority to enforce the require-'ments of section 5 of the FTC Act against many nonbank entities. In addition, state authorities have primary responsibility for enforcing state statutes against unfair or deceptive acts or practices. The Agencies intend to work with these other regulators as appropriate in investigating and responding to allegations of unfair or deceptive acts or practices that involve state banks and other entities supervised by the Agencies

Standards for Determining What is Unfair or Deceptive

The FTC Act prohibits unfair or deceptive acts or practices. Congress drafted this provision broadly in order to provide sufficient flexibility in the law to address changes in the market and unfair or deceptive practices that may emerge.

An act or practice may be found to be unfair where it "causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition." A representation, omission, or practice is deceptive if it is likely to mislead a consumer acting reasonably under the circumstances and is likely to affect a consumer's conduct or decision regarding a product or service.

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The standards for unfairness and deception are independent of each other. While a specific act or practice may be both unfair and deceptive, an act or practice is prohibited by the FTC Act if it is either unfair or deceptive. Whether an act or practice is unfair or deceptive will in each instance depend upon a careful analysis of the facts and circumstances. In analyzing a particular act or practice, the Agencies will be guided by the body of law and official interpretations for defining unfair or deceptive acts or practices developed by the courts and the FTC. The Agencies will also consider factually similar cases brought by the FTC and other agencies to ensure that these standards are applied consistently.

Unfair Acts or Practices

Assessing whether an act or practice is unfair

An act or practice is unfair where it (1) causes or is likely to cause substantial injury to consumers, (2) cannot be reasonably avoided by consumers, and (3) is not outweighed by countervailing benefits to consumers or to competition. Public policy may also be considered in the analysis of whether a particular act or practice is unfair. Each of these elements is discussed further below.

• The act or practice must cause or be likely to cause substantial injury to consumers.

To be unfair, an act or practice must cause or be likely to cause substantial injury to consumers Substantial injury usually involves monetary harm. An act or practice that causes a small amount of harm to a large number of people may be deemed to cause substantial injury. An injury may be substantial if it raises a significant risk of concrete harm. Trivial or merely speculative harms are typically insufficient for a finding of substantial injury. Emotional impact and other more subjective types of harm will not ordinarily make a practice unfair.

• Consumers must not reasonably be able to avoid the injury

A practice is not considered unfair if consumers may reasonably avoid injury. Consumers cannot reasonably avoid injury from an act or practice if it interferes with their ability to effectively make decisions. Withholding material price information until after the consumer has committed to purchase the product or service would be an example of preventing a consumer from making an informed decision. A practice may also be unfair where consumers are subject to undue influence or are coerced into purchasing unwanted products or services.

The Agencies will not second-guess the wisdom of particular consumer decisions. Instead, the Agencies will consider whether a bank's behavior unreasonably creates or takes advantage of an obstacle to the free exercise of consumer decision-making.

• The injury must not be outweighed by countervailing benefits to consumers or to competition.

To be unfair, the act or practice must be injurious in its net effects -that is, the injury must not be outweighed by any offsetting consumer or competitive benefits that are also produced by the act or practice. Offsetting benefits may include lower prices or a wider availability of products and services.

Costs that would be incurred for remedies or measures to prevent the injury are also taken into account in determining whether an act or practice is unfair These costs may include the costs to the bank in taking preventive measures and the costs to society as a whole of any increased burden and similar matters.

• Public policy may be considered.

Public policy, as established by statute, regulation, or judicial decisions may be considered with all other evidence in determining whether an act or practice is unfair. For example, the fact that a particular lending practice violates a state law or a banking regulation may be considered as evidence in determining whether the act or practice is unfair. Conversely, the fact that a particular practice is affirmatively allowed by statute may be considered as evidence that the practice is not unfair. Public

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policy considerations by themselves, however, will not serve as the primary basis for determining that an act or practice is unfair

Deceptive Acts and Practices

Assessing whether an act or practice is deceptive

A three-part test is used to determine whether a representation, omission, or practice is "deceptive." First, the representation, omission, or practice must mislead or be likely to mislead the consumer. Second, the consumer's interpretation of the representation, omission, or practice must be reasonable under the circumstances Lastly, the misleading representation, omission, or practice must be material. Each of these elements is discussed below in greater detail.

• There must be a representation, omission, or practice that misleads or is likely to mislead the consumer.

An act or practice may be found to be deceptive if there is a representation, omission, or practice that misleads or is likely to mislead the consumer. Deception is not limited to situations in which a consumer has already been misled. Instead, an act or practice may be found to be deceptive if it is likely to mislead consumers. A representation may be in the form of express or implied claims or promises and may be written or oral. Omission of information may be deceptive if disclosure of the omitted information is necessary to prevent a consumer from being misled.

In determining whether an individual statement, representation, or omission is misleading, the statement, representation, or omission will not be evaluated in isolation. The Agencies will evaluate it in the context of the entire advertisement, transaction, or course of dealing to determine whether it constitutes deception. Acts or practices that have the potential to be deceptive include: making misleading cost or price claims; using bait-and-switch techniques; offering to provide a product or service that is not in fact available; omitting material limitations or conditions from an offer; selling a product unfit for the purposes tor which it is sold; and failing to provide promised services.

• The act or practice must be considered from the perspective of the reasonable consumer

In determining whether an act or practice is misleading, the consumer's interpretation of or reaction to the representation, omission, or practice must be reasonable under the Circumstances. The test is whether the consumer's expectations or interpretation are reasonable in light of the claims made. When representations or marketing practices are targeted to a specific audience, such as the elderly or the financially unsophisticated, the standard is based upon the effects of the act or practice on a reasonable member of that group.

If a representation conveys two or more meanings to reasonable consumers and one meaning is misleading, the representation may be deceptive. Moreover, a consumer's interpretation or reaction may indicate that an act or practice is deceptive under the circumstances, even if the consumer's interpretation is not shared by a majority of the consumers in the relevant class, so long as a significant minority of such consumers is misled.

In evaluating whether a representation, omission or practice is deceptive, the Agencies will look at the entire advertisement, transaction, or course of dealing to determine how a reasonable consumer would respond. Written disclosures may be insufficient to correct a misleading statement or representation, particularly where the consumer is directed away from qualifying limitations in the text or is counseled that reading the disclosures is unnecessary. Likewise, oral disclosures or fine print may be insufficient to cure a misleading headline or prominent written representation.

• The representation, omission. or practice must be material.

A representation, omission, or practice is material if it is likely to affect a consumer's decision regarding a product or service. In general, information about costs, benefits, or restrictions on the use or

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availability of a product or service is material. When express claims are made with respect to a financial product or service, the claims will be presumed to be material. Similarly, the materiality of an implied claim will be presumed when it is demonstrated that the institution intended that the consumer draw certain conclusions based upon the claim.

Claims made with the knowledge that they are false will also be presumed to be material. Omissions will be presumed to be material when the financial institution knew or should have known that the consumer needed the omitted information to evaluate the product or service.

Relationship to Other Laws

Acts or practices that are unfair or deceptive within the meaning of section 5 of the FTC Act may also violate other federal or state statutes. On the other hand, there may be circumstances in which an act or practice violates section 5 of the FTC Act even though the institution is in technical compliance with other applicable laws, such as consumer protection and fair lending laws. Banks should be mindful of both possibilities. The following laws warrant particular attention in this regard:

Truth in Lending and Truth in Savings Acts

Pursuant to the Truth in Lending Act (TILA), creditors must "clearly and conspicuously" disclose the costs and terms of credit. The Truth in Savings Act (TISA) requires depository institutions to provide interest and fee disclosures for deposit accounts so that consumers may compare deposit products. TISA also provides that advertisements shall not be misleading or inaccurate, and cannot misrepresent an institution's deposit contract. An act or practice that does not comply with these provisions of TILA or TISA may also violate the FTC Act. On the other hand, a transaction that is in technical compliance with TILA or TISA may nevertheless violate the FTC Act. For example, consumers could be misled by advertisements of "guaranteed" or "lifetime" interest rates when the creditor or depository institution intends to change the rates, whether or not the disclosures satisfy the technical requirements of TILA or TISA.

Equal Credit Opportunity and Fair Housing Acts

The Equal Credit Opportunity Act (ECOA) prohibits discrimination in any aspect of a credit transaction against persons on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), the fact that an applicant's income derives from any public assistance program, and the fact that the applicant has in good faith exercised any right under the Consumer Credit Protection Act. Similarly, the Fair Housing Act (FHA) prohibits creditors involved in residential real estate transactions from discriminating against any person on the basis of race, color, religion, sex, handicap, familial status, or national origin. Unfair or deceptive practices that target or have a disparate impact on consumers who are members of these protected classes may violate the ECOA or the FHA, as well as the FTC Act.

Fair Debt Collection Practices Act

The Fair Debt Collection Practices Act prohibits unfair, deceptive, and abusive practices related to the collection of consumer debts. Although this statute does not by its terms apply to banks that collect their own debts, failure to adhere to the standards set by this Act may support a claim of unfair or deceptive practices in violation of the FTC Act. Moreover, banks that either affirmatively or through lack of oversight, permit a third-party debt collector acting on their behalf to engage in deception, harassment, or threats in the collection of monies due may be exposed to liability for approving or assisting in an unfair or deceptive act or practice.

Managing Risks Related to Unfair or Deceptive Acts or Practices

Since the release of the FDIC's statement and the Board's letter on unfair and deceptive practices in May 2002, bankers have asked for guidance on strategies for managing risk in this area. This section outlines guidance on best practices to address some areas with the greatest potential for unfair or deceptive acts and practices, including: advertising and solicitation; servicing and collections; and the

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management and monitoring of employees and third-party service providers. Banks also should monitor compliance with their own policies in these areas, and should have procedures for receiving and addressing consumer complaints and monitoring activities performed by third parties on behalf of the bank.

To avoid engaging in unfair or deceptive activity, the Agencies encourage use of the following practices, which have already been adopted by many institutions:

Review all promotional materials, marketing scripts, and customer agreements and disclosures to ensure that they fairly and adequately describe the terms, benefits, and material limitations of the product or service being offered, including any related or optional products or services, and that they do not misrepresent such terms either affirmatively or by omission. Ensure that these materials do not use fine print, separate statements or inconspicuous disclosures to correct potentially misleading headlines, and ensure that there is a reasonable factual basis for all representations made.

Draw the attention of customers to key terms, including limitations and conditions, that are important in enabling the customer to make an informed decision regarding whether the product or service meets the customer's needs.

Clearly disclose all material limitations or conditions on the terms or availability of products or services, such as a limitation that applies a special interest rate only to balance transfers; the expiration date for terms that apply only during an introductory period; material prerequisites for obtaining particular products, services or terms (e.g., minimum transaction amounts, introductory or other fees, or other qualifications); or conditions for canceling a service without charge when the service is offered on a free trial basis.

Inform consumers in a clear and timely manner about any fees, penalties, or other charges (including charges for any force-placed products) that have been imposed, and the reasons for their imposition.

Clearly inform customers of contract provisions that permit a change in the terms and conditions of an agreement

When using terms such as "pre-approved" or "guaranteed," clearly disclose any limitations, conditions, or restrictions on the offer.

Clearly inform consumers when the account terms approved by the bank for the consumer are less favorable than the advertised terms or terms previously disclosed.

Tailor advertisements, promotional materials, disclosures and scripts to take account of the sophistication and experience of the target audience. Do not make claims, representations or statements that mislead members of the target audience about the cost, value, availability, cost savings, benefits, or terms of the product or service.

Avoid advertising that a particular service will be provided in connection with an account if the bank does not intend or is not able to provide the service to accountholders. Clearly disclose when optional products and services - such as insurance, travel services, credit protection, and consumer report update services that are offered simultaneously with credit - are not required to obtain credit or considered in decisions to grant credit

Ensure that costs and benefits of optional or related products and services are not misrepresented or presented in an incomplete manner.

When making claims about amounts of credit available to consumers, accurately and completely represent the amount of potential, approved, or useable credit that the consumer will receive.

Avoid advertising terms that are not available to most customers and using unrepresentative examples in advertising, marketing, and promotional materials.

http://www . fdic. gOY /news/news/financia1l2004/fiI2604a. html

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FDIC: FIL-26-2004: Unfair or Deceptive Acts or Practices by State-Chartered Banks Mar... Page 6 of 6

Avoid making representations to consumers that they may pay less than the minimum amount due required by the account terms without adequately disclosing any late fees, overlimit fees, or other account fees that will result from the consumer paying such reduced amount.

Clearly disclose a telephone number or mailing address (and, as an addition, an email or website address if available) that consumers may use to contact the bank or its third-party servicers regarding any complaints they may have, and maintain appropriate procedures for resolving complaints. Consumer complaints should also be reviewed by banks to identify practices that have the potential to be misleading to customers.

Implement and maintain effective risk and supervisory controls to select and manage third-party servicers.

Ensure that employees and third parties who market or promote bank products, or service loans, are adequately trained to avoid making statements or taking actions that might be unfair or deceptive.

Review compensation arrangements for bank employees as well as third-party vendors and servicers to ensure that they do not create unintended incentives to engage in unfair or deceptive practices.

Ensure that the institution and its third party servicers have and follow procedures to credit consumer payments in a timely manner. Consumers should be clearly told when and if monthly payments are applied to fees, penalties, or other charges before being applied to regular principal and interest.

The need for clear and accurate disclosures that are sensitive to the sophistication of the target audience is heightened for products and services that have been associated with abusive practices. Accordingly, banks should take particular care in marketing credit and other products and services to the elderly, the financially vulnerable, and customers who are not financially sophisticated. In addition, creditors should pay particular attention to ensure that disclosures are clear and accurate with respect to: the points and other charges that will be financed as part of home-secured loans; the terms and conditions related to insurance offered in connection with loans; loans covered by the Home Ownership and Equity Protection Act; reverse mortgages; credit cards designed to rehabilitate the credit position of the cardholder; and loans with pre-payment penalties, temporary introductory terms, or terms that are not available as advertised to all consumers.

Conclusion

The development and implementation of policies and procedures in these areas and the other steps outlined above will help banks assure that products and services are provided in a manner that is fair, allows informed customer choice, and is consistent with the FTC Act.

Last Updated 3/11/2004 communications@fdlc.gov

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http://www.fdic.gov/news/news/financia1l2004/fiI2604a.html 9111/2009

ADDITIONAL QUESTIONS FOR CHAIRWOMAN BAIR F OM JULY 24, 2009 HEARING:

"REGULATORY PERSPECTIVES ON THE OBAMA ADMINISTRATI .

REGULATORY REFORM PROPOSALS - PART II" Representative Spencer Bachus Response Requested by September 7, 2009

FDIC

AUG 1 7 2009

UDAP Questions:

1. Under the Federal Trade Commission Act, only the Board of Governors of the Federal Reserve System ('Fed") has the authority to issue rules or regulations defining what acts or practices are unfair or deceptive with respect to all banks, including those for which the FDIC or the OCC is the primary federal regulator. Neither the FDIC nor the OCC has the authority to adopt such rules or regulations for the banks they regulate. The Fed, FDIC and OCC, however, have taken the position that the FDIC and the OCC may define what acts or practices they think are unfair or deceptive on a case-by-case basis in the context of administrative enforcement proceedings, and the FDIC has done just that, as reflected in a series of Consent Cease and Desist Orders recently issued by the FDIC, including those regarding Advanta Bank Corporation; American Express Centurion Bank of Salt Lake City, Utah; and the CompuCredit-related cease and desist orders against Columbus Bank and Trust, Columbus, Georgia, First Bank of Delaware, Wilmington, Delaware, and First Bank & Trust, Brookings, South Dakota.

a. The FTC Act explicitly confers upon the Federal Reserve Board, the Federal Home Loan Bank Board, and the National Credit Union Administration Board the authority to "define with specificity" unfair and deceptive acts and practices. While the FTC Act grants enforcement authority to the FDIC and OCC, the Act does not explicitly grant the FDIC and OCC the authority to define unfair or deceptive acts and practices. In other words, under the express language of the Fl'C Act, the FDIC and the OCC do not have the statutory authority to decide for the banks they regulate that a particular act or practice is unsafe or unsound, either by adopting a regulation or on a caseby-case basis in enforcement proceedings.

i. Have the FDIC and the OCC each analyzed this legal issue and prepared written legal opinions which conclude that they each do have the authority to define unfair or deceptive acts or practices on a caseby-case basis?

ii. Have these opinions been reviewed and approved by the General Counsel of each agency?

iii. Has the Fed General Counsel's office reviewed these opinions or performed its own analysis and prepared its own written opinion?

iv. Have any of the opinions that may have been prepared by the FDIC, OCC and/or the Fed regarding this issue been reviewed by any

independent third party, such as the relevant Inspectors General or the Justice Department?

b. What, if any, procedures have been established to assure that the Fed, GCC and the FDIC are all in agreement as to what acts or practices are unfair or deceptive?

1. How do the regulators ensure that the GCC and/or the FDIC do not adopt a UDAP rule in a case through their respective adjudicatory processes that has not been, or is not, also adopted by the other banking agencies? Do you see a problem with the possibility of inconsistent rulings or positions between or among the federal banking agencies regarding what acts or practices are unfair or deceptive?

ii. Are you aware of any inconsistent positions that exist as of today, i.e., situations where the FDIC or GCC or Fed has determined in the context of an administrative enforcement proceeding that a particular act or practice is unfair or deceptive, while one or both of the other agencies have not and do not regard the conduct at issue as a violation of the FrC Act? How would you find out if that were the case?

QUESTIONS ON FAS 166 AND 167

1. Treasury Secretary Geithner has warned that "no financial recovery plan will be successful unless it helps restart securitization markets .... " At the same time, the Financial Accounting Standards Board (F ASB) has recently finalized significant and retroactive changes to securitization accounting that will have a tremendous impact on existing assets and future lending. These changes - which become effective January 1 2010 - could seriously complicate efforts to repair financial markets.

The Administration has made the securitized credit markets the centerpiece of the Financial Stability Plan (through TALF, PPIP, etc). However, in promulgating FAS 166 and 167, F ASB has sought to retroactively eliminate the securitization accounting vehicle known as the "Qualified Special Purpose Entity," which will require some bond investors to "consolidate" an entire pool of loans on their balance sheet, despite only owning 2-3% of the transaction. What will be the impact of this "consolidation" on bond investors who are critical to the extension of credit and the future of our securitized credit markets?

2. The same statutory capital ratios apply to every federally insured depository institution for purposes of determining what their level of capital adequacy is, e.g., well capitalized, adequately capitalized, undercapitalized, etc. However, each of the federal banking agencies also has the authority to require a given institution it regulates to achieve and maintain capital ratios (e.g., for total risk-based capital, core capital, etc.) at specific levels set by the agency, which may be even higher than

the statutory ratios used to define a "well-capitalized" institution. In connection with these individual capital requirements:

a. Does your agency consult with the other federal banking agencies in an effort to achieve uniformity with respect to the factors that will be evaluated and the standards that will be applied in arriving at such individual capital requirements for institutions?

b. Should the federal banking agencies apply the same criteria to determine the capital ratios for a regulated institution?

c. Is there consistency between and among the federal banking agencies regarding the criteria they use to determine whether to establish individual capital requirements?

d. Does your agency use an economic model to determine the capital ratios a given institution should maintain in light of its particular risk profile in order to be considered adequately capitalized or well-capitalized?

1. If you don't use a model, how do you make that determination?

ii. If you do use a model, whose model is it?

1. Was it constructed by your agency alone?

2. Did you discuss it with the other banking agencies, or consult with them regarding what, if any, models they use for such purposes?

3. To the extent you know what differences there are between any model that your agency uses and any model used by any other banking agency, how do you go about resolving those differences, if at all?

4. Do you have a set of standards you use in evaluating capital adequacy models that are employed by the institutions you regulate and, if so, what are they and were they developed in consultation with any other agencies?

Federal Deposit Insurance Corporation

August 27,2008

Honorable Ben S. Bemanke Chairman

Board of Governors of the Federal Reserve System 20th Street & Constitution Avenue, N.W. Washington, D.C. 20551

Re: Request for Comments on the Proposed Rule on Unfair or Deceptive Acts or Practices under Section 5(a) of the Federal Trade Commission Act (Docket No. R-1314); 1

Request for Comment on the Proposed Amendments to the Open-End Credit Provisions of Regulation Z (Docket No. R-1286);2 and

Request for Comment on the Proposed Amendments to the Overdraft Provisions of Regulation DD (Docket No. R-1315). 3

Dear Chairman Bernanke:

The Federal Deposit Insurance Corporation (FDIC) is pleased to comment in support of the proposals of the Board of Governors of the Federal Reserve System (Board) to address problematic practices in consumer credit card lending and overdraft services." The FDIC shares the Board's concerns (and those of the National Credit Union Administration and the Office of Thrift Supervision) because credit cards have become an important component of everyday life for consumers, and the FDIC strongly supports the goal of preventing practices that are unfair or deceptive. We appreciate the opportunity to comment in support of the proposals and to offer our suggestions for enhancements that we believe would further the Board's goals.

From both a consumer protection and credit risk supervisory perspective, the FDIC believes it is important to address unfair or deceptive credit card and overdraft practices using all available tools. Particularly egregious practices warrant enforcement actions; however, taking action on a case-by-case basis is a difficult and resource-intensive challenge, and should be supplemented by clear minimum standards for consumers and the industry. While providing disclosures to consumers is important, credit card practices and disclosures have become more and more complex. As the Board's own testing indicates, disclosures are not always enough to protect

173 Fed.~. 28904 (May 19,2008). 273 Fed.~. 28866 (May 19,2008). 3 73 Fed. ~. 28739 (May 19, 2008).

4 Two of the three proposals, which would amend Regulation Z and Regulation DO, respectively, are being proposed by the Board under its exclusive rulemaking authority, while the proposed amendments to Regulation AA are being proposed by the Board, with counterpart proposals by the National Credit Union Administration and the Office of Thrift Supervision pursuant to their parallel rulemaking authority.

consumers from abusive practices that may be hard to avoid by even the most informed consumer. 5 Therefore, the FDIC believes that the most effective remedy for addressing certain unfair or deceptive credit card practices is a broader approach using regulatory standards, as the Board is proposing. The promulgation of regulations with targeted measures to restrict certain practices will help ensure that all financial institutions operate on a level playing field.

In particular, the FDIC supports the Board's efforts to set standards that allow consumers a reasonable amount of time within which to make credit card payments, as well as to prohibit the practice of setting a cut-off time earlier than 5:00 p.m. for credit card payments. The FDIC also supports permitting financial institutions to apply consumer payments to different credit card account balances, using a choice of reasonable methods in a manner that is easier for consumers to understand. The FDIC strongly supports prohibiting double-cycle billing. Moreover, we think it is appropriate to require issuers to disclose selection criteria used in firm offers of credit that advertise a range of credit limits and interest rates.

With respect to overdraft services, the FDIC supports requiring all institutions to disclose on periodic statements the aggregate dollar amounts charged for paid overdraft and returned item fees. Finally, the FDIC supports the proposal to require institutions that provide balance information through an automated system to disclose the amount of funds available for the consumer's immediate use or withdrawal without including additional funds the institution may provide to cover overdrafts.

Based on our experience, the FDIC proposes enhancements to three areas of the Board's proposal: I) subprime credit cards; 2) application of rate increases to credit card balances; and 3) overdraft services.

Background

Credit cards and overdraft services can be useful tools for consumers when provided responsibly and used carefully. Credit cards have given consumers unprecedented access to credit, and are widely used by households across all demographic and socioeconomic groups. By recent estimates, three-fourths of American households have at least one credit card, and 46% of households carry a credit card balance.f Revolving consumer credit outstanding, which is comprised primarily of credit card debt, continues to grow. Revolving credit outstanding climbed to $962 billion in May 2008, a 7% increase from the previous year and a 15% increase from May 2006.7

Because credit cards are accessible and convenient, many consumers have substituted credit card debt for other kinds of consumer debt. However, there are concerns that American families are growing more reliant on short-term, high-interest credit card debt for financing of daily

l See Remarks of Govemor Randall S. Kroszner, Federal Reserve Bank of Cleveland Community Development Policy Summit (June II, 2008).

6See Federal Reserve 2004 Study of Consumer Finances.

7 See Federal Reserve Statistical Release G.19 Consumer Credit (July 8, 2008).

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necessities, Thirty six percent of credit card users who carry balances owe more than $10,000, and 13% maintain balances of more than $25,000.8

Additionally, a substantial portion of the growth in credit card ownership and usage has been achieved by marketing cards to new classes of borrowers who would not have qualified for credit in the past. These include low-income borrowers, borrowers with little or no credit history, and borrowers with blemished credit histories who exhibit more than a normal risk ofloss.

Debt accumulated by lower-income families, who already are facing challenges making ends meet, is of particular concern. These borrowers are most at risk of quickly becoming overextended. Nearly 30% of households in the lowest income quintile held credit card debt in 2004, up from 15% in 1989.9 Almost one-third of households in the lowest income quintile report that they hardly ever pay their entire balance in full. 10

Another important change affecting consumers is the growth of automated overdraft services that has turned overdraft coverage from an occasional, discretionary accommodation to a widely available, automatically provided service used in lieu of other forms of short-term credit by some bank customers. 11 Moreover, a recent GAO study found that average overdraft fees have risen to $26 per transaction. 12 Given that overdraft fees can be charged on purchases multiple times during a month under most deposit account agreements, the costs can quickly add up to a significant debt, particularly for lower income customers who tend to have smaller deposit account balances.

Increases in credit card borrowing and high overdraft service charges each can increase consumer debt burdens. Excessive consumer debt levels are a concern at any time, but are especially worrisome in the current economic environment when rising costs, housing market turmoil, job concerns and other negative economic conditions are pushing more consumers, particularly lower income consumers, to the limits of their ability to meet their obligations.

The FDIC supervises state-chartered, non-member banks, and more than 1,000 have credit card portfolios. Many also offer automated overdraft services. As a result, the FDIC has a heightened interest in ensuring the best practices for credit card transactions and overdraft services. Our comments are informed by our examination and supervisory experiences, including what we have learned through our consumer complaint process. During the past five years, our Consumer Response Center has received thousands of complaints about credit cards on a wide range of issues, including the calculation of finance charges and annual percentage rates (APR); high or inappropriate fees; failure to credit payments promptly; absent or

8 See Stephanie Jupiter, "Credit Card Debt - What Do Americans Really Owe?" CardTrack, May 31,2007. http://www.cardtrak.com/press/2007.05.31.

9 Supra note 6.

I°Id.

11 Overdraft services are offered by many banks as an alternative to traditional lines of credit or linked account arrangements, which permit transfers from savings or other accounts to cover deposit account overdrafts.

12 See Bank Fees: Federal Banking Regulators Could Better Insure That Consumers Have Required Disclosure Documents Before Opening Checking or Savings Accounts, GAO Report 08-281, at 13-14 (January 2008).

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inadequate disclosures; lack of advance notices for changes in terms; double-cycle billing; and universal default-triggered increases in the APR. We also have received a number of complaints regarding overdraft service charges from consumers who were unaware of how quickly these fees can add up.

Recommendations

Subprime Credit Cards

Some credit card products, particularly those marketed to subprime borrowers, require high opening and other fees but offer little to no credit. The FDIC has seen an increase in some credit card issuers marketing credit cards with a primary goal of collecting significant fees. For example, one business model for these cards has been to offer a line of credit that immediately is exhausted by a "refundable acceptance fee," along with a monthly participation fee.13 Before the cardholder could use the card for actual purchases, he or she might owe nearly the total amount of credit offered in fees and, as a result, would be more likely to exceed his or her credit limit. The combination of these fees - initial and over limit - charged in consecutive or multiple months, particularly if late fees also are incurred, could cause a consumer to be mired in a cycle of debt with virtually no ability to keep pace with the multiple fees charged on a monthly basis.

Given the nature of these card products, the FDIC recommends several enhancements to the Board's UDAl? proposal to further protect consumers and promote transparency. At the outset, issuers of high fee credit cards should be required to prominently disclose all fees up front as a total amount in any solicitation and subsequent disclosures. 14 This is an important step in highlighting the impact of the fees on the credit that at-risk consumers are seeking.

In addition, because the high fees currently charged by some issuers often are deducted from a consumer's available credit limit at the outset, it is inherently deceptive to advertise and offer a line of credit to which the consumer lacks meaningful access. Since 2004, the FDIC and the Board have encouraged institutions to accurately and completely represent the amount of "useable credit" a consumer will receive.P The FDIC recommends that the Board now require that the credit limit advertised and offered by an issuer be the amount available at the outset to

13 The refundability of such membership fees, which most cardholders cannot pay in full up front, was highly conditional under this model.

14 We note with support that the Board already has proposed several changes to Regulation Z, which are aimed at improving the disclosures consumers receive for credit cards that impose high fees at account opening. The Board's May 2008 proposal would require creditors assessing fees at account opening that comprise 25% or more of the minimum credit limit to provide a notice of the consumer's right to reject the plan after receiving the disclosures if the cardholder has not used the account or paid the fee. Currently and under the Board's June 2007 proposal, creditors may collect or obtain a promise to pay a membership fee before required initial disclosures are provided if the consumer can reject the plan. The Board's June 2007 proposal would clarify that assessment of the membership fee is not an activity indicating acceptance of the fee. Finally, the Board is proposing an additional model disclosure forrn that would highlight, but would not total, fees and interest charges at account opening. 73 Fed. ~. at 28868- 28869; 28894.

15 See, e.g., Unfair or Deceptive Acts or Practices by State-Chartered Banks, FDIC FIL-26-2004 (March 11,2004).

4

the consumer for purchases and cash advances. Fees should not be permitted to be deducted from the credit limit.

The FDIC also is concerned that high fee credit cards often are deceptively marketed to subprime borrowers as a way to repair their credit histories by, for example, making regular timely payments and not exceeding the credit limit. There is minimal credible evidence to support this claim. As the Board notes, high fee credit cardholders often derive little effective benefit from use of the cards while incurring the substantial fees that exhaust their credit limit. In addition, the consumer's overall debt level increases. Because high fee credit cards can worsen, not improve, a consumer's credit history, the FDIC recommends that the Board restrict marketing of such credit cards as credit repair products.

The FDIC also recommends that the Board prohibit issuers from assessing multiple fees based on a single event, such as a late payment or a charge that exceeds the credit limit. The piling on or pyramiding oflate fees already is prohibited for closed-end credit under Regulation AA and we believe the same protection should be afforded users of open-end credit.

An additional issue is the financing offees on subprime credit cards. While the FDIC supports the Board's efforts in the UDAP proposal to limit the harmful impact of subprime credit card fees by restricting the financing of high initial security deposits and other fees during the first 12 months, the FDIC recommends that card issuers be prohibited from financing initial fees, security deposits and other costs that exceed 25% of the initial credit limit, rather than 50% as proposed by the Board. Significantly restricting the amount of initial fees that can be financed on the subprime credit card will force issuers of high fee credit cards to be more transparent in their pricing of credit. This change is important because some issuers of high fee credit cards often claim that significant initial fees are necessary to compensate the issuer for the borrower's higher than normal risk. Yet, rather than charging a higher and fully disclosed APR to compensate for increased risk, issuers of these cards instead impose fees that significantly exhaust the amount of useable credit and may not accurately reflect the issuer's actual costs. Because most of the targeted cardholders cannot and do not pay the initial fees in full up front, many of these fees are financed on the credit card, often without the cardholder's full understanding of the impact. Charging and financing high initial fees can be viewed as deceptive because it misleads the cardholder about both the amount of useable credit being offered and its true cost. Limiting financing of initial fees to 25% will improve transparency in the pricing of credit and better equip the consumer with the necessary information to compare the cost of high fee credit cards with any other available options.

Applying Rate Increases to Credit Card Balances

The FDIC supports the Board's proposed general rule that lenders should not be able to increase the APR on existing credit card balances, with limited exceptions. The Board's new rule will help protect consumers from unexpected increases in the cost of transactions that already have been completed.

5

To further protect consumers, the FDIC encourages the Board to consider extending the proposed limitations on APR increases to cover future card balances that are incurred through the expiration date of the current card issued to cardholders who are meeting their payment obligations to an issuer, and are not exceeding the credit limit. Today, credit card agreements often do not have expiration dates, while the credit cards do. Because credit card agreements are open-ended, issuers can change credit card contract terms at any time. Continued use by the cardholder typically indicates his or her acceptance of any subsequent change in terms. Thus, credit card holders do not have a clear and regularly timed opportunity to consider changes in terms, or shop around for other credit cards with lower terms. For cardholders meeting their obligations on the account, and to give both the issuer and the cardholder an opportunity to reevaluate how much the cardholder will pay for credit going forward, the FDIC recommends that the Board consider a provision that would restrict issuers from raising the APR on a cardholder in good standing for future balances through the expiration of the current credit

card. 16

Overdraft Services

The FDIC supports the Board's proposal to prohibit banks from assessing fees for overdraft services unless the deposit account customer is given notice and the opportunity to opt out. It also would prohibit using debit holds as a basis for assessing an overdraft fee. The FDIC also supports the Board's proposal amendments to Regulation DD that would require all institutions that offer overdraft services to provide additional disclosures. 17

The FDIC recommends that the Board consider the following two additional changes, which would make transparent that overdraft services involve the extension of credit, better prevent unfair or deceptive practices, and help consumers avoid overuse of overdraft services, which may lead to a cycle of debt.

TILA Coverage: Coverage under the Truth in Lending Act (TILA) would ~roperly define overdraft services as a form of credit with an accompanying finance charge. g This would trigger required initial disclosures about the cost of overdraft services, which would better enable consumers to compare these costs with the costs of competing forms of credit.

To date, the Board has declined to include as a form of credit under TILA automatic advances covering overdrafts, and has concluded that the fees associated with paying overdrafts are not a

16 In establishing limits on changes in credit card agreement terms, S. 3252, the Credit Card Accountability Responsibility and Disclosure Act of 2008, which was introduced by Sen. Christopher 1. Dodd (D-CT), makes a similar distinction between the credit card and the governing agreement, and would prohibit unilateral changes in the terms of a credit card contract or agreement until the date after the current credit card expires.

11 Supra. note 3.

IS "Credit" under TILA is the "right granted by a creditor to a debtor to defer payment of debt or to incur debt and defer its payment." TILA section I03(e), IS U.S.C. § l602(e). Consumer credit is used primarily for personal, family or household purposes. TILA section 103(h), IS U.S.c. § 1602(h). A "finance charge" is the cost of credit in dollars and includes any charge payable directly or indirectly by the consumer, and imposed directly or indirectly by the creditor, "as an incident to the extension of credit." TILA section I06(a), IS U .S.C. § 160S(a). The APR is measured as the cost of credit expressed as a yearly rate. TILA section 107, IS U.S.C. § 1606; 12 C.F.R. § 226.14.

6

finance charge under TILA in the absence of a written agreement between the borrower and the institution to pay an overdraft and impose a fee. 19 Historically, overdraft advance charges on deposit accounts could easily be distinguished from regular finance charges on credit accounts because, unlike a mutual agreement between a lender and a borrower, the bank unilaterally elected to pay the overdraft and impose a fee as an accommodation.

The overdraft landscape has significantly changed since 1969, when the Board first considered whether fees for overdrafts should be covered under TILA. Unlike occasional, discretionary overdraft accommodation in the past, today's automated overdraft programs often are marketed and function as a regularly used, short-term type of credit. While the agreement governing these services may retain the bank's discretion to pay an overdraft, overdrafts generally are paid automatically and, as a result, the programs are indistinguishable to the consumer from competing overdraft lines of credit or linked accounts, except for the cost. Chronic use of overdraft services is quite expensive and may be inappropriate for many customers who could benefit from more affordable, small-dollar credit.

Coverage under TILA is important to properly characterize these products and to inform consumers about the costs. When the Board amended Regulation DD in 2005 to provide for additional disclosures for promoted overdraft services, it stated that the "adoption of final rules under Regulation DD does not preclude a future determination that TILA disclosures would also benefit consumers. The Board expressly stated in its proposal that further consideration of the need for coverage under Regulation Z may be appropriate in the future.,,2o The FDIC believes the widespread growth and use of automated overdraft services strengthens the case for the Board to bring these products within the coverage ofTILA.

Consumer Consent: The FDIC recognizes, as does the Board, that some benefits may accrue to consumers when an occasional overdraft is paid. On the other hand, repeated usage of overdraft services can lead to recurring high cost fees, create significant debt problems, and cause consumers to fall into a cycle of debt.

Therefore, the FDIC recommends that banks be permitted to offer automated overdraft services to consumers on an opt-out basis up to a limited number, such as five, overdraft transactions per consumer per year. Once a consumer reaches this number of automated overdrafts in a given year, the bank should be required to inform the consumer about possibly less costly alternatives to automatic overdraft programs for which they may qualify, such as linked accounts and overdraft lines of credit. Consumers should have the opportunity at that time to affirmatively select such alternatives for which they qualify, or to choose to continue to receive automatic overdraft coverage. If a consumer does not select an overdraft service (i.e., opt-in), automatic coverage would be discontinued. Consumers are best served by understanding the costs of repetitive use of automatic overdrafts and being informed of and having the opportunity to choose alternatives to managing their persona) finances.

19 UDAP Proposal, 73 Fed.~. at 28927; Regulation DO Proposal, 73 Fed. Bss 28739. 2070 Fed. ~. 29582, 29585 (May 24, 2005).

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Conclusion

The FDIC supports the Board's proposals under its rulemaking authority pursuant to the Federal Trade Commission Act as an important means of protecting consumers from abusive credit card and overdraft practices. The FDIC also supports the proposed amendments to Regulation Z (Truth in Lending). Each of the proposed rules will provide additional protections for consumers and offer banks better guidance on how to provide these products and services responsibly.

The FDIC appreciates the opportunity to comment on this proposed rulemaking. We commend the Board and the other agencies for your leadership in moving to protect consumers and promote the informed, prudent use of these credit products and services.

Sincerely,

Martin J. Gruenberg Vice Chairman

cc: Jennifer 1. Johnson, Secretary,

Board of Govemors of the Federal Reserve System

Mary F. Rupp, Secretary, National Credit Union Administration John E. Bowman, Chief Counsel, Office of Thrift Supervision

8

e FEDERAL DEPOSIT INSURANCE CORPORATION, Washington. DC 20429

SHEILA C. BAIA

CHAIRMAN April 7, 2008

Honorable Ben S. Bemanke Chairman

Board of Governors of the Federal Reserve System zo" Street and Constitution Avenue, N.W. Washington, D.C. 20551

Re: Request for Comment on the Proposed Amendments to the Mortgage Provisions of Regulation Z (Docket No. R-1305)

Dear Mr. Chairman:

On behalf of the Federal Deposit Insurance Corporation, we commend the Board of Governors of the Federal Reserve System (FRB) for proposing amendments to Regulation Z, which implements the Truth in Lending Act (TILA) and Home Ownership and Equity Protection Act (HOEPA), to help address the numerous consumer protection concerns that have arisen in the context of residential mortgage lending. In recent years, a wide segment of the U.S. residential mortgage market experienced a systematic breakdown in lending standards-fed in large part by regulatory arbitrage between bank and nonbank originators. This breakdown in standards has harmed the nation as a whole, and has triggered a severe disruption in global credit markets. The uncertainty that now pervades the marketplace-which is directly attributable to weak underwriting practices-has seriously disrupted the functioning of the securitization markets and the availability of mortgage credit. Lax underwriting contributed to the housing market bubble, just as widespread foreclosures are now contributing to the market's precipitous decline, creating long-term adverse consequences for communities across the country.

These events demonstrate that credit provided on irresponsible or abusive terms does not benefit consumers, and does not provide a firm foundation for economic growth or stability. Restoring the mortgage credit markets to their proper functioning requires clear definition and enforcement of the principles of sound underwriting for mortgage loans. Thus, the FRB has an important opportunity with this rulemaking to establish strong, clear standards for responsible mortgage lending practices that will help prevent these problems from recurring. The FDIC appreciates the opportunity to provide the following comments on the proposed amendments:

1. Scope of the Proposed Rules

The FDIC agrees that the definition ofa higher-priced mortgage loan should include transactions secured by the consumer's principal dwelling for which the annual percentage rate (APR) on the loan exceeds the yield on comparable Treasury securities by at least three percentage points for first-lien loans, or five percentage points for subordinate lien loans. We

think that the APR triggers are appropriate and the FRB should not consider raising them. However, the FDIC recommends that the FRB also incorporate an alternative fee trigger into the definition of a higher-priced mortgage loan, similar to the one currently applicable to HOEPA loans. The risk is great that creditors will circumvent the proposed APR restrictions by lowering interest rates below the APR trigger and instead charging consumers more and higher fees on their loans. This would significantly harm consumers.

As noted above, HOEP A loans as currently defined have not only an APR trigger but also an alternative points and fees trigger to help avoid circumvention. The points and fees trigger defines a HOEPA loan as one in which total points and fees paid by the consumer exceed the greater of 8 percent of the loan amount or a set dollar amount ($561 for 2008).1 Points and fees are defined to include all finance charges except interest, as well as non-finance charges, such as closing costs paid to the lender or an affiliated third party.2 In fact, because HOEPA coverage is based not only on the APR but also on points and fees charged by the lender, some loans qualify only because of the fees charged. Thus, including a fee trigger for higher-priced loans will eliminate the ability of lenders to shift charges to fees not included in the calculation of the APR, thereby avoiding the APR trigger for higher-priced mortgage loans and circumventing the intended protections of the new rules.

In addition, the FDIC recommends that the prohibitions against extending credit without considering a borrower's ability to repay, stated income underwriting, and teaser rate underwriting should apply to negative or deferred amortization products such as the interest-only and payment-option adjustable rate mortgages (ARMs) described in the interagency nontraditional mortgage guidance, regardless of whether they would meet an interest rate or fee trigger.' These points are discussed in more detail below.

Finally, the FDIC recommends that the FRB consider extending the protections proposed in § 226.35(b) to reverse mortgages. The FRB excluded reverse mortgages from this proposal because it has not identified significant abuses in the reverse mortgage market." However, there is evidence that significant abuses do exist in the reverse mortgage market and are on the rise.s Reverse mortgages are becoming increasingly popular with seniors, and unscrupulous lenders are taking advantage of that fact by promoting products that are not always in their best interest.

This is reminiscent of the behavior of unprincipled subprime and nontraditional mortgage lenders as those products gained in popularity. Because reverse mortgages present some unique

potential drawbacks for seniors, including high costs that are not clearly disclosed or understood, the FRB should address these problems sooner rather than later. If the FRS does not reconsider

I The exact dollar amount is adjusted annually. based on the Consumer Price Index.

1 The fee-based trigger also includes amounts paid at closing for optional credit life. accident, health, or loss-ofincome insurance. and for other debt-protection products written in connection with the credit transition.

) See Interagency Guidance on Nontraditional Mortgage Product Risks (Nontraditional Mortgage Guidance). 71 Fed. Reg. 58609.58617 (Oct. 4. 2006).

4 73 Fed. Reg. 1672. 1682 (Jan. 9,2008).

S For example, on December 12,2007, the Senate Special Committee on Aging held a hearing on reverse mortgages, during which Committee members and witnesses discussed the increase in abusive practices directed towards seniors, particularly with respect to advertising. Also, the AARP recently released a report on reverse mortgages. finding that loan costs are extremely high. See Donald L. Redfoot, Ken Scholen, and S. Kathi Brown. "Reverse Mortgages: Niche Product or Mainstream Solution'!" Report on the 2006 AARP National Survey of Reverse Mortgage Shoppers. AARP Public Policy Institute, Washington, DC. December 2007.

including reverse mortgages in this proposal, then at the very least the FRB should quickly analyze the abuses associated with reverse mortgages and provide timely regulations and guidance so that it can curtail those abuses before they become widespread.

2. Ability to Repay

The FRB's rulemaking proposes prohibiting creditors from engaging in a "pattern or practice" of extending credit for higher-priced mortgage loans without regard to a borrower's ability to repay the loan. The FDIC strongly urges the FRB to eliminate the pattern or practice requirement of this provision and simply prohibit outright the practice of making higher-priced mortgage loans without taking into account consumers' ability to repay." As indicated above, we recommend that the FRB extend this prohibition to include all nontraditional mortgages, even those that do not qualify as higher-priced mortgage loans.

The preamble to the FRB's proposal describes the significant injuries that unaffordable loans inflict on individual borrowers, neighborhoods, and all consumers who are in the market for a mortgage loan. The FRB concludes that "[t]here does not appear to be any benefit to consumers from loans that are clearly unaffordable at origination or immediately thereafter."? The FDIC strongly agrees with this point and believes this is exactly why the pattern or practice requirement should be dropped.

Moreover, the pattern or practice requirement inappropriately limits regulatory enforcement as well as civil liability. The FRB's existing commentary indicates that fattern or practice violations depend on the totality of the circumstances in each particular case. Further, pattern and practice violations cannot be established by isolated or individual acts. Thus, proof of a pattern or practice violation requires a wide-ranging or institutionalized policy of making loans without considering a borrower's ability to repay. Meeting this high standard is difficult and costly for both regulatory agencies and consumers." Though the FRB indicates that the pattern or practice requirement is intended to balance potential costs and benefits of the rule, 10 it clearly favors lenders by limiting the number of individual consumer lawsuits and the ability of regulators to pursue individual violations.

b Though the Truth in Lending Act (TILA), as amended by the Home Ownership and Equity Protection Act (HOEPA), currently prohibits lenders from engaging in a pattern or practice of extending HOEPA loans based on consumers' collateral without regard to their repayment ability, the FRS's rulemaking authority allows it to prohibit outright acts or practices that are unfair, deceptive, or designed to evade the provisions of HOEPA. See Section 129(h), 15 U.S.c. § I 639(h); Section 129(1)(2),15 U.S.c. § 1639(1)(2).

7 73 Fed. Reg. at 1687.

8 See Official Staff Interpretations of 12 C.F.R. § 226.34(a)(4).

q See National Consumer Law Center, Truth in Lending Manual § 9.5.2 (6'h ed. 2007), observing that the requirement that a lender engage in a pattern or practice of making HOEP A loans without regard to the borrower's repayment ability "makes such cases difficult and expensive by extending the scope of relevant discovery in an individual case to include the lender's general underwriting practices, and, essentially, its entire loan portfolio." Also see Baher Azmy and David Reiss, Modeling a Response to Predatory Lending: The New Jersey Home Ownership Security Act of 2002,35 Rutgers L. 1. 645, 695 n. 242 (2004), explaining that "[tjraditionally, the "pattern or practice" element of the prohibition has been a hard one for plaintiffs to satisfy, requiring proof of several instances of prohibited conduct in a short period of time."

10 73 Fed. Reg. 1672, 1688 (Jan. 9, 2008).

A substantial proportion of subprime mortgage loans made during the past few years were underwritten without adequate consideration of the borrowers' ability to pay their mortgage and other housing-related expenses, such as real estate taxes and insurance. This has led to widespread turmoil in the residential mortgage markets and is resulting in significant losses to consumers, lenders, and the secondary market. Thus, we believe lenders should not make loans that they know or have reason to believe a borrower cannot repay. Indeed, recent guidance issued by the federal financial regulators instructs lenders to evaluate a borrower's "ability to repay the debt by its final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule ... II By incorporating this guidance into its regulation, the FRB will be able to help level the playing field for bank and nonbank lenders.

While we recognize the FRB's concern for potential civil liability that lenders may face if making unaffordable loans is prohibited outright, we believe those concerns can be substantially mitigated by clarifying in the final regulation that: (l) a subsequent default, in and of itself, could not constitute evidence of inability to repay; and (2) borrowers are presumed to have the ability to repay if their ratio of housing-related and all recurring monthly debt to income (DTI) is no more than 50 percent at mortgage origination. (See the discussion below regarding the use of a 50 percent, or alternative, DTl ratio to measure repayment ability in the context of mortgage lending.) We believe this approach would better balance the possible adverse consequences of such civil liability with the very real injury that will result from failing to establish an enforceable legal standard.

As noted above, we also recommend making the ability to repay requirement applicable to nontraditional mortgages. Nontraditional mortgage products, such as payment option ARMs and interest-only mortgages, carry inherent risks of payment shock and negative amortization. While some institutions have offered these products with appropriate risk management and sound portfolio performance, in recent years more lenders have offered nontraditional mortgages to a wider spectrum of borrowers without adequate risk management, including failure to determine whether borrowers can repay these mortgages assuming a fully amortizing repayment schedule. The combination of risk layering with the broader marketing of nontraditional mortgage loans significantly increases the risk for both consumers and lenders. Requiring lenders to consider repayment ability for nontraditional mortgages within Regulation Z would ameliorate this risk.

Therefore, the FDIC recommends that the FRB utilize its broad rulemaking authority under section 129(1)(2) ofTlLA to apply the ability to repay standard to both higher-priced mortgage loans and nontraditional mortgage loans without requiring that borrowers or regulators establish a "pattern or practice" of unaffordable lending.

3. Debt-to-Income Ratio

The FRB's proposal also makes a "pattern or practice" of failing to consider DTI a presumptive violation of the proposed prohibition against engaging in a pattern or practice of

II See Statement on Subprime Mortgage Lending (Subprime Statement), 72 Fed. Reg. 37569, 37574 (July 10,2007):

Interagency Guidance on Nontraditional Mortgage Product Risks (Nontraditional Mortgage Guidance), 71 Fed. Reg. 58609. 58617 (Oct. 4. 2006).

making higher-priced mortgage loans without regard to borrowers' repayment ability.l ' We commend the FRB for recognizing the importance ofa borrower's DTI ratio, and we agree that consideration of a borrower's DTI ratio "generally is part of a responsible determination of repayment ability."!' However, we believe that the FRB's proposal does not go far enough.

Specifically, we recommend that the FRB also eliminate the "pattern or practice" requirement in connection with consideration of a borrower's DTI ratio and instead require lenders to consider a borrower's DTI ratio when determining repayment ability for all higherpriced mortgage loans, as well as for nontraditional mortgage loans. The primary way lenders ascertain ability to repay is by determining if a borrower has sufficient income to meet his or her housing-related and other recurring monthly expenses. 14 Moreover, quantifying a borrower's repayment capacity by the OTl ratio is a widely accepted approach in the mortgage industry.

To that end, the FRB could set forth a presumption that borrowers have the ability to repay if their OTI ratio is no more than 50 percent at mortgage origination. A loan with a backend OTI ratio above 50 percent is generally recognized within the industry as one that merits additional scrutiny. Such mortgages also are deemed unaffordable under a number of state

laws, I 5 and HOEPA currently prohibits prepayment penalties for covered loans where the borrower's DTI ratio at consummation exceeds 50 percent. 16 As an alternative OTI measure, the FRB could consider using the back-end DTI ratios specified under the mortgage loan programs of the government-sponsored enterprises (GSEs), the Federal Housing Administration (FHA) or the Department of Veterans Affairs. I? In view of the common use of D'I'I ratios as a guide to affordability, it seems incongruous that there is not a D'I'l-based presumption of affordability in the FRB's proposed rule for higher-priced mortgage loans, as well as for nontraditional mortgages. We note that a presumption-based approach provides appropriate flexibility to allow higher DTI ratios in certain limited circumstances, such as where a borrower's disposable income after payment of back-end debt is substantial or where a borrower has significant capital assets or net worth. Conversely, a borrower might be able to show a violation with a lower OTI ratio where, for instance, the lender knew the borrower's income would be declining through an impending divorce or job change. At the same time, the presumption would provide greater

12 12 CFR § 226.34(a)(4); 73 Fed. Reg. at 1725. 13 73 Fed. Reg. at 1689.

14 The Subprime Statement specifies that institutions should maintain qualification standards that include a credible analysis of a borrower's capacity to repay the loan according to its terms.

IS As of February 2008, 11 states had specified that a DTI ratio of more than 50 percent rendered a loan unaffordabIe. See National Conference of State Legislatures http://www.ncsl.org/programs/banking/predlend_intro.htm#Laws. accessed on March 17. 2008.

ie Section 129(c) ofTILA. 15 U.S.c. § 1 639(c).

17 For example, the GSEs and FHA have established back-end DTI ratios ranging from 36 percent to 45 percent for various loan programs. A back-end DTI ratio is calculated by adding monthly housing-related expenses to the total of other monthly obligations and dividing it by monthly gross income. The maximum back-end DTI ratio for Freddie Mac is 45 percent. See, Freddie Mac Single-Family Seller/Servicer Guide, ch. A34.9(d). Fannie Mae's "benchmark debt-to-income ratio is 36 percent of the borrower's stable monthly income," however, it "may occasionally specify a maximum allowable debt-to-income ratio for a particular mortgage product." Fannie Mae Selling Guide, Part X, 703. Moreover, Fannie Mae recognizes that a DTI of 45 percent or greater "significantly increases risk." hi. at 302.08. The back-end ratio for mortgages insured by the Federal Housing Administration cannot exceed 43 percent unless the lender explains in writing why the mortgage presents an acceptable risk. See HUD Mortgagee Letter 2005-16 & HUD Handbook 4155.1, REV-5, Paragraph 2-12 and 2-13.

clarity for both borrowers and lenders in meeting the ability to repay standard to help address the FRB's concerns about litigation risk.

The FDIC also recommends requiring disclosure of the DTI ratio to borrowers ifit is greater than 50 percent. The inclusion of this information in loan disclosure documents would not only benefit consumers by helping them determine the affordability of loan products, but would facilitate investors' ability to conduct due diligence and identify riskier loans, which would help restore credibility and discipline in the secondary market.

4. "Stated Income" Loans

The FDIC recommends that the FRB prohibit "stated income" underwriting outright for higher-priced first- and second-lien mortgage loans, as well as nontraditional mortgage loans such as interest-only loans and payment-option ARMs. The proposed rule currently requires creditors to verify income or assets before making higher-priced mortgage loans. However, the rule provides a safe harbor for creditors who fail to verify income or assets before extending credit if they can show that the amount of income or assets relied on was not materially greater than what the creditor could have documented at consummation. We strongly recommend that the FRB eliminate this safe harbor. Verifying a borrower's income and assets is a fundamental principle of sound mortgage loan underwriting that protects borrowers, neighborhoods, investors, and the financial system as a whole. The proposal does not explain why the safe harbor is necessary or what potential problem it is designed to remedy. We believe the safe harbor is unnecessary, particularly given the flexibility that the FRB has built into the verification requirements. In our view, the safe harbor creates a loophole that will undermine the effectiveness of the stated income prohibition.

Information about income is critical for establishing a reasonable basis that a borrower has sufficient capacity to repay the loan, particularly in the case of subprime and nontraditional loans. The more risk a loan presents, based on its features or the borrower's credit characteristics, the more important it becomes to verify the borrower's repayment capacity. Furthermore, as the FRB points out, consumers typically "pay more for [stated income] loans than they otherwise would" if they had simply provided documentation verifying their income. IS And brokers and other participants in the mortgage origination process have failed to inform many consumers of that cheaper alternative, even though most borrowers can readily document their income through W-2 statements, pay stubs, bank statements, or tax returns.

Both the Subprime Statement and the Nontraditional Mortgage Guidance caution lenders against making "stated income" loans. However, these guidelines set forth a minimum standard and permit exceptions when "there are miti~ating factors that clearly minimize the need for direct verification of repayment capacity."! We believe the FRB should eliminate the proposed safe harbor and stand firm in requiring lenders to adequately verify borrowers' income and assets. Requiring borrowers to document their income will make it far less likely that consumers will receive loans that they cannot afford to repay. Documentation also will provide the markets with greater confidence in the quality of pools of higher-priced and nontraditional mortgage

18 73 Fed. Reg. at 1691.

I~ 71 Fed. Reg. at 58614; 72 Fed. Reg. at 37573.

loans and their projected income streams. Thus, both consumers and the economy as a whole will benefit.

If the FRB does not eliminate the safe harbor, the FDIC recommends requiring disclosures for stated income loans regarding the availability of lower cost fully-documented loans. This disclosure would help give consumers enough information to choose the most appropriate loan product for their needs and would facilitate investors' ability to conduct due diligence and identify riskier loans, which would help restore credibility and discipline in the secondary market.

S. Underwriting for Interest-Only Loans and Payment-Option ARMs

In addition to the preceding recommendations, the FDIC proposes that the FRB prohibit underwriting based only on the initial "teaser rate" for all mortgages described in the Nontraditional Mortgage Guidance, such as interest-only mortgage loans and payment-option ARMs. Over the past few years, lenders have offered an increasing variety of mortgage products-including interest-only loans and payment-option ARMs-to a broader spectrum of borrowers. A substantial number of these loans were underwritten without adequate consideration of the borrowers' ability to repay over the entire term of the loan. Instead, borrowers were qualified at low introductory or teaser rates. Such loans have proven to be unstable long-term financing structures for homeownership, particularly for new or unsophisticated homeowners.

So-called "teaser rate" underwriting is a pervasive and dangerous practice. In effect, it is tantamount to not considering affordability. Many consumers do not understand the payment shock features of their ARMs. Qualifying borrowers based on a low introductory payment rather than a fully indexed, fully amortizing repayment schedule is almost invariably a fatal underwriting flaw that is harmful to both consumers and lenders. Indeed, as previously mentioned, both the Subprime Statement and the Nontraditional Mortgage Guidance instruct lenders to evaluate a borrower's "ability to repay the debt by its final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule.,,2o Thus, the FRB should exercise its rulemaking authority and prohibit "teaser rate" underwriting outright for interest-only loans and payment-option ARMs.

6. Prepayment Penalties

The FDIC believes that the FRB should consider banning prepayment penalties outright for higher cost loans. Prepayment penalties can cause substantial financial injury as borrowers are faced with the difficult choice of either: (1) paying a large penalty to refinance their loan; or (2) continuing with a loan they cannot afford and. by doing so, stripping their home of equity or losing their home through foreclosure. As the FRB observed, "[t]he injuries prepayment penalties may cause consumers are particularly concerning because of serious questions as to whether borrowers knowingly accept the risk of such injuries.":" These risks are particularly devastating to borrowers' trapped in mortgages that are, or shortly will be, unaffordable because

20 Id.

21 73 Fed. Reg. at 1694

they can significantly hinder efforts to refinance or otherwise structure loan work outs. As a practical matter, many subprime borrowers are not offered the choice of a loan without prepayment penalties. Moreover, unlike the prime market, most subprime loans include a prepayment penalty. For example, whereas about 70 percent of the balance of subprime loans over the past four years included a prepayment penalty, prepayment penalties are comparatively rare (about 3 percent) among prime mortgage 10ans.22 Therefore, banning these penalties will ensure that consumers-particularly subprime consumers-will be able to refinance or sell their homes within a reasonable amount of time.

If the FRB does not prohibit prepayment penalties outright, it should at least reduce the amount of time that prepayment penalties are permitted for higher-priced mortgage loans from five years, as is currently proposed, to two years. The proposal explains that a five-year period "would prevent creditors from 'trapping' consumers in a loan for an exceedingly long period.,,2J We believe that five years is an exceedingly long period.

One of the reasons that the agencies issued the Subprime Statement was their concern about the growing popularity of ARM products that had low initial payments based on an introductory rate, which expired after a short period of time and adjusted to a variable rate for the remainder of the loan.24 Many lenders aggressively marketed these loans as "credit repair" products. They assured consumers that they would qualify for a lower-priced product at the time that the introductory rate expired-often in two years. Prepayment penalties that extend beyond that timeframe have made such representations illusory. Borrowers who have demonstrated a positive payment history and could qualify for a lower interest rate are not likely to be able to refinance their loans due to the sheer cost of prepayment penalties, which often can amount to

six months' worth of interest. In addition, many fixed subprime loans currently have prepayment penalties with terms of25 to 36 months." Therefore, we recommend alternatively that the FRB limit prepayment penalties for higher-priced mortgage loans to two years or less.

Further, if prepayment penalties are not banned altogether, the FDIC recommends that the FRB prohibit them for higher-priced mortgage loans at least 180 days before the reset date, rather than 60 days as currently proposed. This longer period provides a more realistic timeframe than 60 days, particularly for subprime borrowers, because it affords consumers more time to refinance into a mortgage product that meets their financial needs. Unlike the prime market where interest rates are widely published, interest rates in the subprime market are nontransparent, making it more difficult and time-consuming for consumers to determine the costs of refinancing. Finding competitively priced refinancing is particularly challenging when housing prices are decreasing or mortgages are less available. In recognition of that fact, HOPE NOW Alliance members have agreed to contact at-risk borrowers 120 days prior to the initial ARM reset for all 2/28 and 3/27 products.

~~ FDIC calculations using the Loan Performance Securities Database. Data for prime loans represent nonagency originations.

23 Id

!4 72 Fed. Reg. at 37569.

25 FDIC calculations using the Loan Performance Securities Database.

7. Yield Spread Premiums (YSPs)

The FDIC recommends that the FRS prohibit the use ofYSPs to compensate mortgage brokers. The current proposal merely provides for additional disclosures and the consumer's written consent to the maximum amount of compensation that he or she will pay the broker. We do not believe that such disclosures will be effective. Disclosures alone will not address the fundamental problem with YSPs, which is that they provide an inappropriate financial incentive for mortgage brokers to steer consumers to unaffordable loans. The FRB describes a yield spread premium as "the present dollar value of the difference between the lowest interest rate the wholesale lender would have accefted on a particular transaction and the interest rate the broker actually obtained for the lender.,,2 We think a ban on YSPs, as the FRB has defined them, would eliminate compensation based on increasing the cost of credit and make the amount of the compensation more transparent to consumers.

The inherent conflicts presented by a broker compensation system that rewards increasing the cost to the borrower have been debated for years. To be sure, mortgage brokers can provide valuable services and should receive fair compensation. However, there are ample alternative means of compensation available, such as flat fees or fees based on the total principal amount of the mortgage, which would not present skewed incentives to increase borrower costs and which would be much more transparent and understandable to borrowers. The same can be said for commissions paid to loan officers. Borrowers should continue to have the option to finance the broker's compensation. However, a ban on YSPs will ensure that broker compensation will not be based on steering the consumer to a loan that is more expensive than one for which he or she would otherwise qualify. Thus, the FRB should ban any amount of compensation based on increasing the cost of credit, including compensation that is tied to the APR, or that is not a flat or point-based fee.

8. Advertising

While the FDIC generally supports the advertising provisions proposed by the FRB, we recommend that the FRB restrict use of the term "fixed," or similar terms, in marketing information for adjustable rate or hybrid mortgage products. The term "fixed" has long been used to describe traditional mortgage products with no payment shock features. Using the term to describe adjustable rate products, which have "fixed" rates for only a few years, or interestonly products, which may have "fixed" rates but also the potential for significant payment shock, can be inherently misleading.

9. Escrows

The FDIC strongly supports the FRB's proposal to require escrows for real estate taxes and insurance and believes it would be appropriate to extend the time period to opt out beyond the 12-month period currently proposed. Real estate taxes and insurance are required expenses that lenders should always consider in evaluating a borrower's capacity to repay a mortgage loan. The failure to pay taxes and insurance is a form of default that can lead to foreclosure, causing substantial financial injury to borrowers. Requiring escrows ensures that borrowers will

2~ 73 Fed. Reg. at 1698.

have sufficient funds set aside to meet their obligations and avoid the potentially dire consequences for failing to pay their taxes and insurance in a timely manner. The requirement also benefits the economy overall. as fewer foreclosure actions will result ifborrowers are able to afford all housing-related expenses. not just principal and interest. We applaud the FRB for making this proposal.

10. State Law

The FDIC also agrees that the proposed rules should not preempt state laws unless they are inconsistent. Many states have proven to be innovative laboratories for the development of consumer protections in recent years. They have been especially active in efforts to address predatory mortgage lending, loan flipping, prepayment penalties, the fiduciary obligations of mortgage brokers, and many other areas. States should not be prevented from providing their citizens with strong consumer protections, and we applaud the FRB for allowing them to continue to do so.

We appreciate the opportunity to comment and encourage the FRB to consider the FDIC's recommendations, which will help eliminate the mortgage lending practices that have hurt so many consumers and led to deterioration and uncertainty in our financial markets. We commend you for your leadership in moving decisively to apply common sense rules of underwriting to all mortgage originators. as well as your advocacy for market innovations to serve the mortgage credit needs oflow and moderate income communities. We believe that these simple, basic rules will allow substantial flexibility and latitude to provide affordable mortgage options to lower income populations within a prudential framework that wil1 assure their long term affordability.

Sincerely,

Sheila C. Bair

cc: Jennifer J. Johnson Secretary

Board of Governors of the Federal Reserve System Washington, D.C. 20551