U.S. regulators warn but do little about risky loans

Mortgages with little or no down payments are easier to get than before


WASHINGTON - For two months, federal banking regulators have signaled their discomfort about the explosive rise in risky mortgage loans.

First they issued new "guidance" to banks about home-equity loans, warning against letting homeowners borrow too much against their houses. Then they expressed worry about the surge in no-money-down mortgages, interest-only loans and "liar's loans" that require no proof of a person's income.

The impact so far? Almost nil.

"It's as easy to get these loans now as it was two months ago," said Michael Menatian, president of Sanborn Corp., a mortgage broker in West Hartford, Conn. "If anything, people are offering them even more than before."

The reason is that federal banking regulators, from the Federal Reserve to the Office of the Comptroller of the Currency, have been reluctant to back up their words with specific actions. For even as they urge caution, officials here are loath to stand in the way of new methods of extending credit.

"We don't want to stifle financial innovation," said Steven D. Fritts, associate director for risk management policy at the Federal Deposit Insurance Corp. "We have the most vibrant housing and housing-finance market in the world, and there is a lot of innovation. Normally, we think that if consumers have a lot of choice, that's a good thing."

At the Federal Reserve, officials face issues similar to those posed by the stock market bubble of the late 1990s. Alan Greenspan, the Fed chairman, warned about "irrational exuberance" in the stock market but did not try to pop the bubble. Today, Greenspan acknowledges that housing prices in some areas are "frothy," but he and other top regulators do not think it is their job to push them back down.

The main issue for regulators is whether banks and other lenders are properly managing their own risk, and the lenders are looking good.

They have hedged their risks by bundling mortgages into securities that are then sold to investors around the world. And if interest rates go higher, they have shifted much of the risk onto consumers, because a growing share of homeowners have taken on adjustable rate mortgages. At the same time, the lenders have built sturdier financial institutions through mergers and the breakdown of barriers to interstate banking.

Bert Ely, an independent banking analyst who was among the first to recognize the crisis at savings and loan institutions in the 1980s, said the banks are far sounder today. "It's a night-and-day difference," Ely said. "No comparison."

But consumers - and perhaps the broader economy - are taking on more risk. About 60 percent of mortgages last year had adjustable interest rates, many with artificially low teaser rates that expire after the first few years. If a mortgage rate rises from 4 percent to 6 percent, just slightly above current levels, the monthly payment can soar by roughly 30 percent when the teaser rates come to an end.

The jolt can be higher for people with interest-only loans. In addition to facing higher rates, borrowers also have to start paying down the principal they owe after about five years. People who put no money down face a different risk: If housing prices decline, even slightly, owners who need to sell their homes may need thousands of dollars beyond the sale price to pay off their loans.

Indeed, because the main risks are to consumers rather than to financial institutions, some critics say regulators have been too timid. "The prevailing attitude is that if you're taking on a risky mortgage, you're an adult and you're taking on the risk yourself," said Rep. Barney Frank, the Massachusetts Democrat who is co-sponsoring a bill that would impose tougher rules against so-called predatory lending practices.

Even as federal regulators try to reinforce what they say are standard practices for proper underwriting, a growing number of state banking regulators worry that more steps may be necessary.

"The issue is suitability," said Joseph A. Smith Jr., the state banking commissioner of North Carolina. "If you are a stockbroker, you don't put grandma into a hot tech stock. In the mortgage market, you may have a product that is perfectly OK for a thoracic surgeon or a professional basketball player, but is not appropriate for a nurse at Baptist Hospital in Winston-Salem."

Unconventional mortgages have soared in popularity in recent years. About a third of homebuyers in the last 18 months did not put any money down, according to a recent survey of home purchasers by the National Association of Realtors.

More than 25 percent of all new mortgages in the last year have been interest-only loans, which allow buyers to postpone principal payments for three to five years but which become much more expensive afterward.

Despite their hands-off approach, some banking regulators are worried that banks and other mortgage lenders may not have properly judged the risks to themselves.

They warn that speculative buying has increased, with many people hoping to resell new houses and condominiums before the construction is even finished.

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