Loan Industry Fighting Rules on Mortgages

Before this year, the Fed had applied an extra set of protection from abusive lending practices to a subset of subprime borrowers under the Home Ownership Equity Protection Act of 1994. The Fed has applied the law to fewer than 1 percent of all mortgages — those with interest rates at least eight percentage points above prevailing rates on Treasury securities.

Some economists and housing experts say the Fed’s lax oversight helped enable lending companies to reap enormous profits by providing millions of unsuitable and abusive loans to homeowners who often did not fully understand the terms or appreciate their risk.

As of January, the most recent month of available data, about a quarter of all subprime adjustable mortgages were delinquent, twice the level of the same period last year. Lenders began foreclosure proceedings on about 190,000 of these mortgages in the last three months of 2007.

The new rules would apply extra protection to any mortgage with an interest rate three percentage points above Treasury rates. Officials said that they would cover all subprime loans, which accounted for about a quarter of all mortgages last year as well as many exotic mortgages known in the industry as “Alt-A” loans.

These loans are made to people with relatively good credit scores but who might provide little documentation of their income or assets, or who make smaller than usual down payments or purchase loans that have unusual terms, like interest-only payments for an initial period.

Many mortgage brokers and bankers complain that the lower threshold would unnecessarily include many borrowers who are not at risk from abusive practices.

“There are a lot of community banks that have shied away from these loans because nobody wants to be a higher-priced lender,” said Karen Thomas, a lobbyist for the Independent Community Bankers. “With the trigger being set so low, it is encroaching on traditional, common sense mortgages. Our fear is it will result in less credit availability, which is not what we need in an already tight credit market.”

But consumer groups say that the proposed rules are already weak and that efforts to further weaken them would render them all but useless.

“The Fed has accurately diagnosed that this is a brain tumor and responded by prescribing an aspirin,” said Kathleen E. Keest, a former state regulator who is now a senior policy counsel at the Center for Responsible Lending, a group supporting home ownership. “In the industry, there is a fair amount of denial. They just don’t get it. There is a calamity within the industry, and they don’t have a new script yet, so they rely on the old script, which is that regulation will raise costs.”

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But, she went on, “What we now see is that the unintended consequences of deregulation are worse. Their line is that regulation will cut back access to credit. That’s been their line ever since the small loan laws were adopted in the early 1900s.”

At the same time, letters urging the Fed to further tighten the rules were sent by Sheila C. Bair, the Republican head of the Federal Deposit Insurance Corporation, as well as senior members of the House Financial Services Committee.

In her letter, Ms. Bair, whose agency regulates many banks, urged the Fed to apply the proposed restrictions to loans that are three percentage points or higher than equivalent Treasuries. To prevent lenders from evading the limit by creatively structuring the loan and fees, she also suggested that the Fed impose the tighter restrictions if the loan fees exceeded a dollar amount.

While the Fed plan would require disclosures that could make it harder for lenders to include hidden sales fees that are usually paid to the mortgage broker, Ms. Bair suggested that the plan go further and ban some practices.

The plan, for instance, would require subprime lenders to explicitly describe fees that are now hidden. But Ms. Bair has proposed the elimination of such fees, saying such a ban would “eliminate compensation based on increasing the cost of credit and make the amount of the compensation more transparent to consumers.”

Ms. Bair also proposed making it easier for borrowers to sue lenders without having to show that they were engaged in a pattern of abusive practices, which is a requirement under the proposed Fed rules. She said that forcing borrowers to show a pattern of abuse “clearly favors lenders by limiting the number of individual consumer lawsuits and the ability of regulators to pursue individual violations.”

Ms. Bair also recommended that the Fed eliminate a so-called safe harbor provision in the proposal that protects lenders who fail to verify the income or assets of a borrower in some circumstances.

Copyright © 2008 The New York Times

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