The Federal Reserve on Tuesday proposed new mortgage lending rules to protect consumers against fraud and deception, but consumer advocates said lenders would still have the ability to make the kinds of bad loans that triggered the sub-prime lending crisis.
The Fed proposal would require lenders who make sub-prime loans to consider borrowers’ abilities to make payments and to verify that they have the income and assets they claim.
It also would require better disclosure of special bonuses that mortgage brokers earn when they write loans at higher rates than a borrower is eligible to receive.
The Fed proposal consists of measures specifically aimed at higher-cost sub-prime loans for people with poor credit, as well as broader rules that would apply to all home loans. The measures were released for a three-month public comment period, after which the Fed could adopt them with or without revisions.
For all loans, mortgage brokers would be required to disclose in writing whether they received “yield-spread premiums,” or bonuses for selling loans at interest rates that were higher than a borrower qualified for.
Consumer activists said the measures were a step in the right direction but didn’t go far enough. For example, borrowers who suspect their lender broke the rules would have to prove “a pattern or practice” of abusive lending, noted Kurt Eggert, a professor at Chapman University’s law school in Orange and a member of the Fed’s Consumer Advisory Council.
“To prove what the lender’s real policy is, a borrower would have to examine potentially hundreds of loan files, while the lender would be screaming about privacy for other borrowers,” Eggert said. “This could be an insurmountable burden.”
In announcing the new measures, Fed Chairman Ben S. Bernanke said, “Mortgage market discipline has in some cases broken down, and the incentives to follow prudent lending procedures have, at times, eroded.” The proposed rules, he said, aimed to prevent improper lending without “unduly restricting mortgage credit availability.”
Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corp., described the rules as “clear, balanced, common-sense standards” and noted that they would apply to brokers and independent lenders rather than just the national banks watched over by U.S. financial regulators.
Experts said Tuesday that some of the Fed proposals were helpful, such as the rule that lenders must verify income and assets for sub-prime loans. The proposal came in response to lenders offering “no-documentation” loans and charging a premium for them.
Some borrowers used the loans to buy homes for speculative purposes, betting on rising prices. Others claim that they were lured into mortgages they didn’t fully understand. With home values falling, many of these borrowers now are facing foreclosure.
Yet consumer advocates said the Fed could have done more. For instance, they complained that disclosures of yield-spread premiums -- bonuses that they consider kickbacks -- are easily overlooked or ignored in a mountain of other loan documents.
“Unsophisticated borrowers [who] may be too easily convinced to take out a loan with unreasonable charges and [yield-spread premiums] that do not benefit the borrower are an abuse that disclosure will not solve,” John Taylor, president of the National Community Reinvestment Coalition, said in a statement.
He added: “A borrower shouldn’t need to be a lawyer or financial expert to protect themselves from unfair and deceptive lending that leaves them vulnerable to foreclosure.”
Some congressional Democrats were also unsatisfied and indicated that they would push lawmakers to approve stricter requirements next year.
“We now have confirmation of two facts we have known for some time,” said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee. “One, the Federal Reserve System is not a strong advocate for consumers, and two, there is no Santa Claus. People who are surprised by the one are presumably surprised by the other.”
Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee, said the Fed did not go far enough in restricting prepayment penalties, which make it costly for cash-strapped borrowers to pay off their existing loan and refinance into one that is more affordable.
The Fed would prohibit such penalties on high-cost loans for at least 60 days before a scheduled rate hike. But Dodd said the penalties should be eliminated altogether.
Also Tuesday, California Gov. Arnold Schwarzenegger and U.S. Treasury Secretary Henry M. Paulson Jr. met with homeowners and others in Stockton, one of the U.S. areas hardest hit by loan defaults and foreclosures, to discuss government efforts to help struggling homeowners.
This month the Bush administration unveiled a plan that calls on lenders to voluntarily freeze low introductory rates for certain borrowers for as long as five years.
Some people have criticized the plan, saying it may only help about one-third of the nearly 1.8 million homeowners whose loans will adjust to sharply higher rates in the next 2 1/2 years.
But Paulson defended the plan, saying it would help keep the housing slump from nudging the broader economy into recession.
“The biggest risk to the economy right now is the housing slump,” he said. “The problem is going to get much worse unless we can do something about it.”
An upbeat Schwarzenegger carried a message of hope and help, predicting that California’s declining home values would turn around soon.
“This crisis is not going to last,” he said. “It’s a bump in the road.”
Trudy Crawford, who bought a home in Stockton two years ago, was among those attending the town hall session. Crawford said her mortgage payments were going up at a time when a death in the family had already set her back. She told the crowd her lender has been no help.
“Where’s the help for us?” Crawford asked. “I’m raising two grandchildren.”
The governor replied, “I want to find out why your lender can’t help you.” The room erupted in applause.
“Stockton was a good spot for the officials to experience the community’s pain and frustration,” said Paul Leonard, director of the California office of the Center for Responsible Lending, an advocacy group for borrowers. The governor and Paulson, he said, went “right into the belly of the beast.”
Peterson reported from Washington and Lifsher from Sacramento.