The matter of Wachovia Bank, et al. v. Watters is now before the Supreme Court, a case that sounds duller then pavement except that the outcome could radically change the lending industry and many other industries as well.

The case revolves around the matter of "preemption," the legal principle that federal law trumps contrary and conflicting state and local laws. In this instance, Wachovia informed Michigan and other states in 2003 that it would originate mortgages under federal banking regulations and not state rules. Watters -- meaning Linda A. Watters, Commissioner of the Michigan Office of Insurance and Financial Services -- took the matter to court claiming the state had jurisdiction over mortgage subsidiaries operated by national banks in part because they were separate corporate entities.

In 2005 the 6th Court of Appeals ruled that preemption was real, and that Wachovia was on well-established legal ground, legal ground going back to the National Banking Act of 1864. Watters lost.

Those who favor Watters say federal standards are weak, grossly outdated and anti-consumer. Those who favor Wachovia argue that if states can make individual rules the marketplace would be needlessly complex and costly for a variety of products and services.

Based on precedent you would expect Watters to lose every time. In fact, she lost unanimously in the circuit court decision.

Yet for some reason the Supreme Court has elected to look into this case, meaning that the "settled" precedent of preemption may not be so settled. Why would the Supreme Court open the matter if it was content with the status quo? How would Watters impact mortgage lending if Wachovia lost?

To answer these questions you need to look at a local law which would have increased the penalties for mortgage discrimination in Montgomery County, MD -- a suburb just outside Washington, DC.

In a letter to the judge who heard a challenge to the proposed Montgomery County law, John E. Bowman, chief counsel with the Office of Thrift Supervision, told the court that regulating national lenders and their subsidiaries was the sole turf of the federal government. OTS, he said, was the "primary regulator of all federally chartered and many state-chartered thrift institutions, which include savings banks and savings and loan associations."

Bowman then provided a list of disputes between the federal government and state and local governments. In each instance federal rules won out.

OTS, said Bowman, "has previously addressed preemption of similar Georgia, New York, New Jersey, and New Mexico lending legislation. Indeed, these opinions specifically concluded that state laws that prohibit the financing of single premium credit life insurance or that restrict points, fees, and prepayment penalties or other forms of compensation are preempted."

In particular, Bowman said that federal rules preempt "state laws purporting to impose requirements regarding: (1) the ability of creditors to require insurance or other credit enhancements; (2) the terms of credit; and (3) loan-related fees."

Not only are national lenders exempt from most state laws, they're also exempt from much federal consumer oversight. As the Federal Reserve Bank of New York explains, the enforcement of federal consumer regulations is generally left to the Federal Trade Commission, but only "when the institution is not a federally insured depository institution."

The Bowman letter says "OTS occupies the field of the regulation of the operations of federal savings associations, including their lending operations, to enhance safety and soundness and enable federal savings associations to conduct their operations in accordance with best practices by efficiently delivering low-cost credit to the public free from undue regulatory duplication and burden."

Not everyone, however, agrees with Bowman's claims. Critics ask such questions as: Are mortgage and credit card interest rate as low as possible? Just how safe and sound is it to allow the widespread use of the "stated income" mortgage applications? How is the public interest served by the widespread origination of interest-only and option ARM mortgage products?

Alternatively, federal regulators are concerned primarily with the overall security and safety of the banking system. One measure of safety and security concerns profits: A banking system with widespread losses would substantially impact the economy -- and not for the better.

The Federal Deposit Insurance Corporation reports that in 2004 national lenders had profits of $103.5 billion -- almost twice what they earned eight years earlier in 1996. As to federally regulated savings institutions, they took in $18.2 billion in 2004, far more than the $7 billion in profits earned in 1996.

It will be shocking beyond measure if the Supreme Court agrees with Watters. Should the Supremes side with Michigan you can bet that the first order of business in many states will be to look at mortgage fees, credit card charges, prepayment penalties and requirements to purchase single-premium insurance as a condition of getting a mortgage.

No less important, federal and state lawmakers clash in many fields, including environmental standards, auto emissions, vehicle mileage and drug prices. Should Watters come away with a clear-cut victory, the result would echo throughout the economy.

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

Published: December 5, 2006

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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 .