Here is the real scandal of the subprime bubble that tanked Wall Street last week-- and is why 2.2 mllion subprime borrower face foreclosure on their homes.

State governments actually passed a range of anti-predatory lending laws to stop ripoffs by subprime lenders, but as we discuss over at Progress States today, Bush's White House legally worked to shut down many of those state efforts. More below the fold:

With millions of families facing these exploitive lending practices, the question is why the government didn't act to stop it? The answer is that the states did act-- but the federal government, backed by campaign contributions from predatory lenders, shut them down and helped create this mortgage crisis.

Back in 1994, Congress did pass the Home Ownership and Equity Protection Act to protect homeowners. The law was meant to be the floor for protection: states could go above and beyond the protections offered in the Act and since then, over 30 states have passed laws offering more protection than the federal Act.

Bush Administration Preempts State Laws: However, state and local efforts have been pre-empted by the Office of Thrift Supervision (OTS) and the Office of the Comptroller of the Currency (OCC). The OCC, in particular, has promoted a theory of "field preemption" that would preempt all state laws and insulate national banks and their operating subsidiaries from virtually all state regulation. This effectively destroys any state's ability to regulate the business activities of all banks. The OCC preempted Georgia's Fair Lending Act, which had offered protection against predatory lending, including outlawing extreme prepayment fees or penalties, unreasonable monthly payments, and increased interest rates after default.

This was followed by the OCC preempting the New Jersey Home Ownership Security Act, which prohibited abusive lending practices and challenges to other state laws have followed. Adding to the attack on state authority, some in Congress proposed laws to further preempt state authority over mortgage lending. One of the chief sponsors of the preemption bill was Congressman Bob Ney, who was convicted of bribery for his role in the Abramoff scandal.

Courts and Preemption: The courts have largely backed this federal preemption of state authority, with federal courts striking down predatory lending laws in a number of states. After the Sixth Circuit Court of Appeals struck down state banking laws in Michigan, the Supreme Court agreed to hear the case and will be making a ruling soon on whether some parts of state regulation will survive preemption.

Yet whatever the courts decide now, the damage has been done. During the critical period of the recent housing bubble, as speculation and predatory lending ran riot, state regulators were so involved in defending their laws in court that their effectiveness was undermined and the costs are being borne by some of the most vulnerable borrowers in the market.

Monetary Policy as "Regressive Tax": What made the problem most acute for these subprime borrowers is that when the Federal reserve hiked interest rates, most borrowers could refinance to long-term loans whose rates have barely moved in the past three years. People with poor credit, however, absorbed the brunt of the shift, since their contracts usually hiked their mortgage rates in tandem with the Federal Reserve rate hikes-- and either their contracts or their bad credit prevented them from escaping these mortgages as their monthly payments skyrocketed. As Business Week wrote just a week ago, "About $265 billion worth of subprime loans are scheduled to have their rates adjusted upward in 2007...Many stretched homeowners may soon be paying 11% or 12% on their mortgages, while everyone else can get 30-year fixed-rate loans at a little over 6%...In effect, monetary policy is turning into a regressive tax."

The new Congress seems more willing to grapple with the predatory lending problem, with Congressman Barney Frank from Massachusetts saying he would introduce legislation to restrict subprime lending. But while the Federal government may be trying to help the situation now, the debacle of recent years is a lesson in why federal preemption of state laws is often a recipe for disaster. While minimum federal standards are often needed, states are usually aware more quickly of problems appearing locally that need additional regulation, such as the explosion of predatory lending. We should remember in coming years that by tying the hands of state governments, federal regulators made a bad problem far, far worse.