Realty Check

Subprime Guidance From The Fed: Do They Really Have To?

I’m going round and round with the folks at the Federal Reserve about this new “guidance” they issued for subprime lenders. The guidance covers various “consumer protection principles,” including “approving loans based on the borrower’s ability to repay the loan according to its terms.”

Another very important guideline concerns prepayment penalties. The Federal Reserve is now saying that “the period during which prepayment penalties apply should not exceed the initial reset period, and that institutions generally should provide borrowers with a reasonable period of time (typically at least 60 days prior to the reset date) to refinance their loans without penalty.”

This is vital given the number of subprime borrowers who either didn’t understand the nature of their adjustable rate loans or were somehow tricked by predatory lenders. Banks are now aggressively trying to help borrowers refinance out of risky loans so as to stem the tide, or should I say tidal wave, of delinquencies.

But here’s my question: “Guidance.” What is that, and must it be followed?

“Guidance which is issued by the banking agencies, this is guidance to the institutions they regulate, so it’s for the commercial banks the thrift institutions, the credit unions,” says David Skidmore, a spokesman for the Fed. He also points me to the following sentence in the “guidance”: "The Agencies will take action against institutions that exhibit predatory lending practices, violate consumer protection laws or fair lending laws, engage in unfair or deceptive acts or practices, or otherwise engage in unsafe and unsound lending practices.”

I’m still not sure if this means that all banks and lenders must follow the guidelines. Of course the big names would, but much of the trouble in subprimes came from independent lenders, not banks. And what about the new breed of aggressive mortgage brokers?

As part of the news release on this guidance, Fed Gov. Randall S. Kroszner writes, “It’s only good business sense for the lenders and it is the right thing to do for the borrowers sake.” Nowhere in his statement does he say, “do it, or else!” And some might not think these guidelines make good business sense, some like, John Robbins, Chairman of the Mortgage Bankers Association, who responded quickly to the guidelines with the following statement: "This is a strong statement that will help curb abuses, but will likely also constrain consumer credit choices.”

Mmm, doesn’t sound like a rave to me.

Questions?  Comments?