Fed Approves Rules Restricting Sub-Prime Loans

WASHINGTON (AP) _ Confronted by record foreclosures, the Federal Reserve is ready to give U.S. home buyers more protection from the types of shady lending practices that have contributed to the country's housing crisis.
Chairman Ben Bernanke and his central bank colleagues approved a plan Monday that would crack down on dubious lending practices that have hurt many of the riskiest "subprime" borrowers -- people with tarnished credit histories or low incomes.
Rules made public in December would:
• restrict lenders from penalizing risky borrowers who pay loans off early.
• require lenders to ensure those borrowers set aside money to pay for taxes and insurance.
• bar lenders from making loans without proof of a borrower's income.
• prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the homes value.
• curtail misleading ads for many types of mortgages.
• bolster financial disclosures to borrowers.
Consumer groups have complained that the new rules are not strong enough. Lenders worry they are too tough, could limit mortgage options for people and made it harder for some to obtain financing.
Expected approval of the plan comes as the Fed copes with investors' dwindling confidence in the financial health of the nation's two biggest mortgage companies, Fannie Mae and Freddie Mac. They hold or back $5.3 trillion of mortgage debt, about half the outstanding mortgages in the United States.
The Fed and the Treasury Department, consulting closely over the weekend, are exploring ways to shore up the companies. If one or both were to fail, it would deal a devastating blow to the already crippled housing market. Mortgages would become even harder to get and rates would rise.
The new lending rules may not get a test for some time because there are fewer home buyers these days, given all the problems in the housing and credit markets. Also, some of the shady practices -- along with some lenders -- have not survived, felled by the mortgage meltdown.
"Clearly this is closing the barn door after the fact," said Susan Wachter, a professor of real estate and finance at the University of Pennsylvania's Wharton School of Business. Yet, she said, "this is a very important move. It absolutely will make a difference going forward."
Ken Wade, chief executive of NeighborWorks America, a network of housing organizations that promotes neighborhood revitalization, hoped the new rules would curb future abuses. "It's not going to do anything (to fix) the problems we're wrestling with right now, but there's still a need to create the rules going forward," he said.
Much will hinge on effective enforcement.
The plan would apply to new loans made by thousands of lenders, including banks and brokers. It would not cover current loans.
Those different lenders fall under a patchwork of regulators at the federal and state levels. So it will be up to each of these authorities to enforce the new provisions. "We have a very fragmented regulatory system. This will be a challenge to enforce. This will be daunting," Wachter said.
The Mortgage Bankers Association had asked the Fed to act carefully. Overly broad rules "could prevent many lenders from making loans to those borrowers most in need of credit and significantly increase the costs of credit for all borrowers," the association said in a filing with the Fed.
Under former Chairman Alan Greenspan, the Fed came under criticism for not acting earlier to address dubious lending. Some critics complained that Greenspan, who ran the Fed for 18 1/2 years, was not a forceful enough regulator, especially during the 2001-2005 housing boom when easy credit spurred subprime home loans and many exotic new types of mortgages.
Bernanke, who took over the Fed in early 2006, also took heat for what critics believe was lax oversight.
"How disappointed I am with all of us," Rep. Maxine Waters told Bernanke during a recent House hearing. "Members of Congress, for what appears to have been weak oversight of our regulatory agencies, and our regulatory agencies for what appears to have been weak oversight of our financial institutions," said Waters, D-Calif.
Bernanke replied: "Admittedly, it would be better if it had been earlier, but we have responded." He believed the rules would be "very effective" in stemming abusive lending practices.
Congress is working on legislation that would put into law some tougher provisions than those envisioned by the Fed. Prospects for final action are uncertain.