Fed offers lender rules

Crackdown sought on deceptive mortgages for weak borrowers

December 19, 2007|By New York Times News Service

WASHINGTON -- The Federal Reserve, acknowledging that home mortgage lenders peddled deceptive loans to borrowers who had little chance of repaying them, proposed a broad set of new restrictions yesterday on exotic mortgages and high-cost loans for people with weak credit.

The new rules would force mortgage companies to show that customers can realistically afford their mortgages. They would also require lenders to disclose the hidden sales fees often rolled into interest payments, and they would prohibit certain types of advertising.

Borrowers would be able to sue lenders if they violated the new rules, though homebuyers would be allowed to seek only a limited amount in compensation.

"Unfair and deceptive acts and practices hurt not just borrowers and their families," said Ben S. Bernanke, chairman of the Federal Reserve, "but entire communities, and, indeed, the economy as a whole."

The new regulations, expected to be approved in close to their proposed form after a three-month period for public comment, amount to a sharp reversal from the Fed's long-standing reluctance to rein in dubious lending practices before the subprime market collapsed this summer.

The proposed changes, which do not apply to standard mortgages for borrowers with good credit, stopped short of banning all heavily criticized practices in subprime lending and did not go as far as many consumer groups had sought. But they won praise as worthwhile steps from some industry critics who had long complained that the Federal Reserve under its former chairman, Alan Greenspan, persistently ignored signs of trouble.

"Reading these proposals today is almost painful," said Dean Baker, co-director of the Center for Economic Policy Research, a liberal research group in Washington. "These are all just simple, common-sense regulation. Why couldn't Greenspan have done this seven years ago?"

If the measures had been in place earlier, they would have applied to as many as 30 percent of all mortgages made in 2006.

Some advocacy groups that had warned for years about reckless practices said the Fed's move was too little and too late.

"The Federal Reserve's proposed guidance is riddled with loopholes and exceptions that will undermine its effectiveness," said Deborah Goldstein, executive vice president of the Center for Responsible Lending, a nonprofit group in Durham, N.C. "The proposals fall far short of what was needed and in some ways fall short of where the industry was already headed."

The new rules would do nothing to help the hundreds of thousands of people who are either already defaulting on subprime mortgages or are likely to lose their homes when their introductory teaser rates expire and their monthly payments jump by 30 percent or more.

Soaring default rates among subprime borrowers have caused a crisis on Wall Street, all but shutting down the subprime mortgage market since August because lenders could no longer raise the cash to make new loans. The Bush administration has pushed for voluntary agreements aimed at avoiding some, but far from all, of the foreclosures expected next year.

The American Banking Association praised the Fed's action as "an important proposal that would make a significant difference in protecting mortgage borrowers." But the industry group warned that some provisions might go too far. "We worry that replacing important lending flexibility with rigid formulas might also limit lending to some creditworthy borrowers."

In Congress, leading Democratic lawmakers said the Fed had been too cautious.

Rep. Barney Frank of Massachusetts, chairman of the House Financial Services Committee, said the central bank showed it was "not a strong advocate for consumers." Sen. Christopher J. Dodd of Connecticut, chairman of the Senate Banking Committee, called the proposal a "step backward."

Despite their limitations, the central bank's new proposals would nonetheless cut a wide swath across the nation's fragmented mortgage system. They would govern practices for all mortgage lenders, regardless of whether they are banks, thrift institutions or independent mortgage companies. And they would apply regardless of whether a lender is supervised by federal or state regulators.

The most important indicator that the Fed wanted to throw down the gauntlet is in how it defined the mortgages that would be subject to special consumer protection.

Under its existing rules, based on the Home Ownership Equity Protection Act of 1994, the Fed's extra protections applied to less than 1 percent of all mortgages - those with interest rates at least 8 percentage points above prevailing rates on Treasury securities.

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