Fed Says Subprime Woes Aren't Spreading to Other Markets

A senior staffer for the Federal Reserve said the Fed is not seeing signs that problems in the subprime mortgage market are spreading to other other market segments.

"At this time, we are not observing spillover effects from the problems in the subprime market to traditional mortgage portfolios or, more generally, to the safety and soundness of
the banking system," Fed Division of Banking Supervision and Regulation Director Roger Cole told the Senate Banking Committee.

Cole said that the Fed is concerned about and is monitoring the mortgage market; that less than half of subprime loans came from federally regulated banks; and that housing credit
deterioration is focused on the narrow subprime sector.

Meanwhile, a representative of the Conference of State Bank Supervisors told the hearing that Congress should not bail out subprime lenders and brokers who made risky mortgage loans to borrowers with bad credit, but lawmakers can take several steps to protect consumers going forward.

Avoid Taxpayer Funds

"I strongly encourage Congress to avoid using taxpayer funds to bail out the subprime lenders, brokers and investors that generated our current problem," Joseph Smith, the North Carolina Commissioner of Banks, said in remarks prepared for a Senate hearing.

Brown said subprime borrowers with home equity and incomes to support reasonable mortgages can refinance their loans. But borrowers with no-money-down loans and little income are in an "unsustainable" situation, he said. "Without a massive government bail-out, these mortgage loans will likely result in foreclosure."

Brown also urged Congress to require lenders to set a default loan for subprime borrowers at a 30-year fixed rate, and to modernize the Federal Housing Administration (FHA) so that it can lend to some subprime borrowers. Lawmakers should also take the step of requiring lenders to consider a borrower's ability to repay a loan before making one, he said.

The hearing, chaired by Connecticut Senator Christopher Dodd, is focusing on a wave of defaults among subprime borrowers, the shutdown of at least 20 lenders, and fears of wider economic damage. (The House Financiial Services Subcommittee on Financial Institutions is holding a similar public hearing Tuesday, Match 27.

Managers from major lending companies like HSBC Finance, Countrywide Financial , General Electric's (GE is the parent company of CNBC) WMC Mortgage unit and First Franklin Mortgage are set to appear at the Senate Banking Committee hearing.

Executives from New Century Mortgage , which faces a federal criminal probe into securities trading and accounting, refused to attend.

Dodd, a presidential hopeful and Senate Banking Committee chairman, on Wednesday laid some of the blame for the problems in the industry on the Fed.

"Pattern of Neglect"

"A pattern of neglect by federal bank regulators ... precipitated the subprime mortgage crisis that could cause 2.2 million homeowners to lose their homes," he said.

Congress may have its work cut out for it on the subprime issue, with Dodd and other lawmakers talking in recent days about protecting borrowers and strengthening housing programs.

Massachusetts Democratic Rep. Barney Frank is targeting late 2007 for passage of a bill to curtail predatory lending like that seen behind the widening mortgage market crunch.

The subprime mortgage sector emerged in recent years to lend money to people with poor credit at high interest rates.

Dodd said that by late 2003, Fed analysts noticed that mortgage lending standards were slipping, raising default and foreclosure risks. But at around the same time, he said, Fed leadership was encouraging development of alternative home loans, such as adjustable rate mortgages (ARMs).

"Soon thereafter, the Fed embarked on 17 consecutive interest rate increases, meaning that people with ARMs were now facing substantial payment shocks in the future," he said.

Dodd called it "a perfect storm that has contributed to the hardship and heartache that millions of homeowners now face."

On Wednesday, fears that high-risk mortgage market turmoil would spread eased somewhat after two battered lenders managed to secure enough money to stay afloat.

For instance, Fremont General said it was selling $4 billion of subprime residential loans to an unidentified buyer, lifting the company's beleaguered shares.

But it was too early to say whether such fresh funding would keep a lid on the housing debacle, which many analysts worry could have a ripple effect through the U.S. economy.