Fed Takes Half-Hearted Measures to Halt "Unfair and Abusive" Mortgage Practices

Why am I cynical about the measures that the Federal Reserve proposed today to stem predatory mortgage lending? They smack of being an obligatory effort taken in the face of Congressional and media pressure. The Fed appears to have done little in the way of its own investigation of what is happening in the field and who is affected. Our impression is based admittedly on limited conversations with Fed personnel, speeches by Fed presidents making forceful arguments for “caution” (read inaction) in intervening in subprime lending, and the failure of the Fed to advance any proposal until now, late in the game.

And the measures speak for themselves. While anything would be helpful, these measures are comparatively modest.

The move may be problematic if the Fed isn’t keen about enforcement. Heretofore, the Office of the Comptroller of the Currency (part of the Treasury Department) has been more proactive in monitoring banks involved in subprime lending and using its powers to restrict abuses under existing legislation (the Home Ownership and Equity Protection Act, now thirteen years old). The new proposal consolidates responsibility for subprime-related lending regulation under the not-keen-to-regulate Fed, both Federal and state chartered banks. While the Wall Street Journal indicates that these proposals will give state attorneys general more power to take enforcement actions, it’s nevertheless worrisome that a not-very-enthusiastic regulator is creating new policy and will have primary responsibility for overseeing it at a large number of institutions. Also note that mortgage brokers not part of banks are addressed only indirectly (the new rules impose restrictions if compensation to brokers depends on the interest rate charged to borrowers).

From the Wall Street Journal:

The Federal Reserve Tuesday proposed rules that mark the central bank’s biggest regulatory response to the country’s mortgage turmoil to date…

The central bank’s proposal is broad and would cover everything from the types of loans that can be made to the types of disclosures that must be provided. It also would require lenders to seek more verification of income on high-cost loans and would put limits on the compensation that mortgage brokers can receive. In addition, the proposal would ban brokers or creditors from improperly influencing home appraisals….

Once the Fed’s proposal is finalized, it is unclear what its eventual impact will be. The market for subprime mortgages has drastically dried up in recent months and it is possible that the Fed’s proposal might eventually prohibit practices that are no longer common…

The central bank’s action comes after months of jawboning from Democrats in Congress, who alleged that inaction by the central bank helped certain loose lending practices proliferate during the recent rise and fall of the mortgage market.

One of the Fed’s top critics in this area — Senate Banking Committee Chairman Christopher Dodd (D., Conn.) — immediately slammed the Fed’s proposal, saying the central bank “took a significant step backwards.”

“It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer protection functions,” Mr. Dodd said. “This is a clear signal that legislation is necessary to help protect homeowners from abusive and predatory lending practices.”

Mr. Dodd complained that the Fed only prohibited certain prepayment penalties on subprime loans, among other things.

But not all Democrats panned the proposal. Rep. Paul Kanjorski (D., Pa.) said the proposal would “increase consumer protections and enhance market stability.”

The proposal would apply to all lenders – state and federally licensed – touching every corner of the mortgage market. The Fed has never used its authority like this before…..

The proposal said these loans shouldn’t be made without regard to a borrower’s ability to repay, without verifying the income and assets of the borrowers, with a prepayment penalty in certain circumstances, and without establishing that borrowers pay insurance and taxes on the property for at least 12 months.

The proposal would also “generally” ban lenders from “directly or indirectly paying mortgage brokers in connection with consumer credit transactions secured by a consumer’s principal dwelling, unless the mortgage broker enters into a written agreement with the consumer” and provides certain disclosures. Creditors wouldn’t be banned from paying brokers if the compensation isn’t determined by the borrower’s interest rate.

The proposal would require that most prepayment penalties on high-cost loans expire at least 60 days before an adjustable-rate loan resets from its starter rate into a higher rate. Many prepayment penalties on subprime adjustable-rate mortgages made in 2005 and 2006 ran right up to or beyond the reset date.

Though the Fed’s proposal would apply to all subprime lenders, the central bank wouldn’t be charged with enforcing its proposal for every company. But a final rule would make it much easier for state attorneys general, the Federal Trade Commission, and private lawsuits to go after those who violate the new policies.

“These proposals alone will not end all of the problems in the mortgage market,” Mr. Kroszner said. “We do believe, however, that the carefully considered rules that we are proposing today will go far toward ensuring reasonable credit options for consumers while stemming the problems we have seen.”

The plan would ban seven marketing practices, including marketing loans as having “fixed rates” when the fixed rate is for only a limited period of time. Lenders would also be banned from “advertising claims of debt elimination if the product would merely replace one debt obligation with another,” according to the proposal.

Additional commentary from Bloomberg highlights the role of Congressional pressure:

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….

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.

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