Banks who refuse to modify bad loans or stop the avalanche or foreclosures that have swept the US in the last few months may have something more substantial than federal regulators to worry about.  A decision by the Supreme Court has given state attorney generals the power to litigate against major mortgage lenders who they say have perpetrated consumer fraud by marketing bad loans that would be impossible to pay back.

ComplicatedCuomo vs. Clearing House

The ability of states to sue banks comes from a case started in 2005 by New York attorney general Elliot Spitzer. The case was taken up by his replacement, Andrew M. Cuomo, and was passed by a 5-4 Supreme Court decision in June. In July, Illinois attorney general Lisa Madigan filed a civil rights suit against Wells Fargo for predatory lending, using the Cuomo case as precedent. Other state attorneys general are following suit, and banks have started looking for ways to get around the charges brought against them.

One way banks avoid litigation is to switch their charter. Wells Fargo originally cooperated with the attorney general Madigan in Illinois, but stopped as soon as it switched to a national charter. Ms. Madigan said that switching to a national charter makes it very easy for banks to hide their misconduct.

State Based Regulation

It is possible that giving the state attorney general the power to bring banks to task could be the way to fill the regulatory gaps that federal regulatory agencies found themselves faced with when they were trying to crack down on predatory lending and other risky bank practices early this year. While state suits may not have been able to prevent the financial crisis, they certainly might have prevented it from growing out of control.

Banks have already begun to fight states’ ability to regulate, lobbying the government to change the rules so that state laws will not be more restrictive than the federal laws. Where banks are required to answer to the attorney general, they put up a façade of cooperation, telling homeowners to start a dialogue but making it difficult for them to do so by putting them on hold or requiring loads of paperwork. States like Arizona where foreclosures as many as 7,000 a month are starting to take the gloves off, and banks who continue to practice predatory lending may be in for a fight.

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