Tuesday, December 18, 2007

Fed Plans to Tighten U.S. Mortgage Rules After Crisis (Update5)

By Craig Torres and Alison Vekshin

Dec. 18 (Bloomberg) -- The Federal Reserve proposed new rules for subprime mortgages, including a ban on low- documentation loans and limits on penalties for borrowers who prepay their debts.

The plans, the Fed's biggest regulatory initiative since Chairman Ben S. Bernanke took office in February 2006, are aimed at curbing lending practices that contributed to record foreclosures. Board members unanimously voted in a hearing today to make lenders responsible for determining whether borrowers can afford their mortgages even after low starter rates expire.

``Mortgage-market discipline has in some cases broken down and the incentives to follow prudent lending procedures have, at times, eroded,'' Bernanke said at the meeting. The proposed new rules ``were carefully crafted'' to deter ``improper lending'' without ``unduly restricting mortgage credit availability,'' he said.

Bernanke is aiming to preserve the Fed's consumer- protection role after Democratic lawmakers blamed it for lax oversight and introduced legislation to set rules for mortgage lenders. Today's proposals received mixed responses from legislators, consumer advocates and finance-industry officials.

`Deeply Disappointing'

``This proposal is deeply disappointing,'' Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said in a statement. ``It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions. This is a clear signal that legislation is necessary.''

Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, commended the Fed and said markets are served ``when reasonable rules'' are in place.

Finance-industry officials have warned that a crackdown on the subprime mortgage market would curtail lending in the midst of the housing recession.

``The agency has taken a measured approach,'' said Chris Stinebert, president and chief executive of the American Financial Services Association, a Washington-based trade group representing credit card and other consumer-finance companies.

Jim Carr, chief operating officer of the National Community Reinvestment Coalition, said the Fed's recommendations are ``a very comprehensive and thorough proposal to purge predatory lending.''

Scope of Mortgages

Today's package covers all high-cost mortgages, which are defined as loans with rates at least 3 percentage points above a comparable Treasury security for first mortgages and 5 percentage points for second loans, or home-equity loans.

The proposed rules are now submitted for additional public comment before policy makers finalize them and put them into effect. Fed Governor Randall Kroszner, the Fed board's chief liaison with the banking industry, said ``we will continue to work as expeditiously as possible to implement these consumer protections.''

The Fed governors voted in favor of tightening restrictions on so-called pre-payment penalties, requiring the escrow of taxes and insurance, and banning loans made without verification of income or assets.

``We want consumers to make decisions about home mortgage options confidently, with assurance that unscrupulous home mortgage practices will not be tolerated,'' Bernanke said. ``Unfair and deceptive acts and practices hurt not just borrowers and their families, but entire communities, and, indeed, the economy as a whole.''

Promise in July

Bernanke pledged to lawmakers in July that he'd propose new mortgage rules to ``address specific practices that are unfair or deceptive.''

The proposal also went beyond its initial scope of consideration, and recommended new disclosure rules aimed at mortgage brokers, appraisers and solicitors. The rules apply to both prime and subprime loans.

Fed governors approved prohibiting lenders from paying brokers fees in excess of what the borrower initially agreed. The proposal bars coercion of appraisers, and defines seven advertising practices as misleading or deceptive.

``I'm pleased that the Federal Reserve has started the public process of exercising its authority to set national standards for all lenders,'' Federal Deposit Insurance Corp. Chairman Sheila Bair said in an e-mailed statement. The Fed's actions address ``lax lending standards that are the heart of the current credit crunch.''

Congressional Rebukes

Congressional leaders repeatedly rebuked the Fed this year for failing to curb the lending abuses that contributed to soaring subprime-mortgage foreclosures. At a June 13 hearing, House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, threatened to strip the central bank of its consumer-protection authority if it didn't act.

``The Federal Reserve System is not a strong advocate for consumers,'' Frank said in a statement today after the proposals.

Subprime loans are usually made to people with poor or incomplete credit histories. Delinquency rates on subprime loans reached 16.3 percent in the third quarter, from 14.8 percent the previous three months.

Lending standards at banks have tightened even for their best customers, causing mortgage borrowing to slow to the weakest pace in nine years in the third quarter, according to Fed figures.

Slide in Building

Housing figures today showed builders broke ground on the fewest new homes in 14 years last month as sales dropped. Housing starts fell 3.7 percent from October, to a 1.187 million annual rate, the Commerce Department said in Washington.

``We always lock the barn door after the horse has gone,'' said David Wyss, chief economist at Standard & Poor's in New York. Fed officials are hoping to ``restore confidence in this category'' of mortgages so lenders ``will start making these loans again,'' he said.

The Fed has cut its benchmark interest rate by 1 percentage point since September in an effort to ``forestall'' risks that the housing slump and credit-market strains will tip the economy into recession. The Bush administration this month negotiated a freeze of up to five years on some subprime mortgage rates.

The central bank has rule-writing power over all financial institutions for disclosures and preventing abuse, while it shares enforcement authority with other agencies and states.


In the House of Representatives, lawmakers last month passed legislation sponsored by Frank that would require lenders to ensure borrowers are issued loans they can afford to repay. It would also strengthen oversight of mortgage brokers. Dodd introduced similar legislation in the Senate last week.

Congress last week also gave final approval to legislation that would expand the ability of the Federal Housing Administration to insure mortgages for more subprime borrowers, sending it to President George W. Bush for his signature.

The U.S. Treasury, which has led an effort to fix interest payments on subprime loans at risk of foreclosure for up to five years, approved of the Fed plan today.

``We support the development of such rules, which recognize the need to protect consumers without unnecessarily restricting their access to credit,'' said Robert Steel, undersecretary for domestic finance.

Former Treasury Secretary Lawrence Summers, who has advocated that policy makers strengthen their response to the mortgage crisis, speaks with Democratic Senator Charles Schumer of New York tomorrow at a housing event in Washington.

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