You would think with the growing debate regarding the value and utility of Fannie Mae and Freddie Mac that the two mortgage giants would want to stay away from anything which smacks of controversy. Instead, they have each decided not to buy mortgages which contain mandatory arbitration clauses, a policy which makes as much sense as docking Navy submarines because they get poor mileage.

Since Fannie Mae and Freddie Mac buy about four of every ten mortgages nationwide, this is a big deal. It means most loans will not contain such clauses and it means something else: Consumers are potentially losing important leverage.

Fannie Mae has announced that it will "not invest or accept delivery of any mortgage that is subject to mandatory arbitration provisions."

Meanwhile, Freddie Mac said in a December news release entitled "Freddie Mac Promotes Consumer Choice With New Subprime Mortgage Arbitration Policy," that as of August 2004 "it would no longer invest in subprime mortgages originated on or after that date that contain mandatory arbitration clauses."

"Freddie Mac believes that all homeowners should be able to voluntarily choose the mortgage dispute resolution option they believe to be in their best interests," said Paul Peterson, chief operating officer, Freddie Mac. "We remain committed to helping families build wealth through homeownership."

Really? Why does Freddie Mac favor "choice" only for lucky sub-prime borrowers? If built-in arbitration clauses are okay for the rich, why not for the poor? Given that attorneys often decline small cases, how are poor and credit-challenged borrowers helped by getting rid of the sure leverage available through built-in arbitration agreements?

Without a built-in dispute resolution clause, both sides must agree to arbitration after the loan has been established. But why would a lender agree to arbitration once a problem arises? After all, if one side has lots of cash and attorneys and the other does not, why would the stronger party agree to arbitration? What would you do if you were a lender?

Binding arbitration, in the best case, means that the borrower and lender will have disputes settled by an independent third party. The decision of the arbitrator is final and cannot generally be appealed in court.

Arbitration eliminates much of the cost and time associated with lawsuits -- and that means fewer legal fees for the nation's trial attorneys and the potential for speedy and fair dispute resolution. It also means that the results of an arbitration cannot be used in class-action suits, those wonderful settlements where consumers get beads and trinkets while attorneys pocket fees worth millions of dollars.

In other words, if you have a good binding arbitration agreement in a mortgage and the lender fails to make a timely tax payment, overcharges interest, or doesn't fully credit additional principal payments, you don't have to wait years for a court to resolve the dispute, nor must you send a lawyer's children through college. Binding arbitration lets you do things quickly and with minimal cost -- it gives muscle to consumer complaints at the very moment they need muscle.

But arbitration -- like the court system -- is not perfect. For example, some contracts stipulate that the arbitrator must be a third-party service that has an agreement to handle much or all of the arbitration work for a given company or lender. Such relationships inherently create a conflict-of-interest.

As well, one can have an arbitration agreement infested with "gotcha" clauses -- say a limit on lender liability but not borrower exposure -- or a requirement for borrowers to pay arbitration costs even if they win or big upfront costs even before the process begins.

Thus, if Fannie Mae and Freddie Mac said they will not purchase any mortgage with a binding arbitration clause where the arbitrator has a business relationship with the lender or investor, there would be cheers. If Fannie Mae and Freddie Mac banned "gotcha" clauses and said they will only purchase loans where the arbitration is conducted under the rules and authority of the independent and impartial American Arbitration Association, then both companies would deserve praise.

Even better, if Fannie Mae and Freddie Mac wrote standardized arbitration clauses that were fair and neutral for both borrowers and lenders then we would all have something to applaud.

But that's not what they did.

As government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have special benefits and privileges not available to private companies -- and as a consequence they also have special obligations to the public. Because they are GSEs, and as a matter of common sense, Fannie Mae and Freddie Mac must re-think their broad prohibitions against mandatory arbitration clauses -- before giving still-more ammunition to those who decry their special status and benefits.

For more articles by Peter G. Miller, please press here.

Published: February 10, 2004

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Peter G. Miller, also known as OurBroker®, is the author of six real estate books -- including The Common-Sense Mortgage -- and is the original creator and host of America Online's Real Estate Center. Peter's weekly columns appear in more than 100 newspapers nationwide, he is also published in a variety of other media outlets and he is a frequent speaker at national events and conventions. Peter welcomes your questions, comments, and news releases via e-mail at .