WASHINGTON The Federal Reserve moved Tuesday to protect homebuyers from dubious lending practices, its most sweeping response to a mortgage meltdown that has forced record numbers of people from their homes.
The Fed has been under attack for not doing more to stem the crisis as hundreds of thousands of people lost the roof over their head. The situation has raised the odds the country will fall into recession, unhinged Wall Street, racked up multibillion-dollar losses for financial companies and resulted in political finger-pointing over who was to blame.
The proposed rules, endorsed by the Federal Reserve Board in a 5-0 vote, would crack down on a range of shady lending practices that have burned many of the nation's riskiest "subprime" borrowers those with spotty credit or low incomes who have been hardest hit by the housing and credit debacles. The rules also would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers.
"Unfair and deceptive acts and practices hurt not just borrowers and their families but entire communities and, indeed, the economy as a whole. They have no place in our mortgage system," Fed Chairman Ben Bernanke said. "We want consumers to make decisions about home mortgage options confidently, with assurance that unscrupulous home mortgage practices will not be tolerated."
If ultimately adopted, the plan would apply to new loans made by thousands of lenders of all types, including banks and brokers. It would not cover loans already made.
The proposal would restrict lenders from penalizing risky borrowers who pay loans off early, require lenders to make sure these borrowers set aside money to pay for taxes and insurance and bar lenders from making loans without proof of a borrower's income. It also would 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 home's value.
The plan disappointed both supporters and opponents of tougher home-lending regulations.
Mortgage lenders worried that the Fed plan was too tough and could crimp customers' choices. "We worry that some of the product restrictions could make it harder for bankers to tailor products for their customers and communities and result in some creditworthy customers not being able to obtain a loan," said Edward Yingling, president of the American Bankers Association.
Consumer groups and Democrats in Congress complained that the proposal doesn't provide sufficiently strong safeguards for borrowers.
"The Fed has done too little, too late," said Kathleen Day, spokeswoman for the Center for Responsible Lending, a group that promotes homeownership and works to curb predatory lending. "We don't think it is strong enough to protect people in the future and does nothing to help people left holding the bag now."
Consumer advocates wanted an outright ban on prepayment penalties. These penalties, they say, deter homeowners from refinancing on more favorable terms. The penalties can be hard on borrowers who want to get out of adjustable-rate mortgages that reset from a low introductory rate to a much higher one they have trouble paying off.
However, mortgage industry representatives argued that prepayment penalties ensure that lenders receive a minimum return if loans are paid off early and can provide borrowers with a benefit of lower upfront costs or lower interest rates.
Another disappointment to consumer groups: To make a case for a possible violation, the lender has to have engaged in a pattern of making loans without considering the borrowers' ability to repay. An individual incident would not be sufficient by itself.
Before taking effect, the public, industry and others can weigh in. The Fed will then vote again, and the rules could be revised.
The proposal offers Bernanke, who took over the helm in February 2006, an important opportunity to put his imprint on the Fed's regulatory powers. Some critics have complained that Bernanke's predecessor Alan Greenspan, who ran the Fed for 18 1/2 years failed to act as a forceful regulator, especially during the 2001-05 housing boom, when easy credit spurred lots of subprime home loans and many exotic types of mortgages.
When the housing market went bust, subprime loans were most heavily affected.
Of the nearly 3 million subprime adjustable-rate loans surveyed by the Mortgage Bankers Association from July through September, a record 4.72 percent entered the foreclosure process during those months. At the same time, a record 18.81 percent of the subprime adjustable-rate loans were past due.
When home values weakened, borrowers were left with loan balances that eclipsed the value of their homes. They also were clobbered when their loans reset with much higher interest rates.
The House has passed legislation that would put into law some tougher provisions than contemplated by the Fed. A similar bill is pending in the Senate.
For both risky and not-so-risky borrowers, the Fed also proposed:
• Prohibiting certain types of misleading or deceptive advertising for home mortgages. For instance, it would bar using the term "fixed" to describe a rate that is not truly fixed over the life of the entire loan. It also would require that all applicable rates or payments be disclosed in ads with equal prominence as advertised introductory "teaser" rates.
• Requiring lenders to provide financial disclosures to borrowers early enough for them to use while shopping for a mortgage. Lenders could not charge fees except for a fee to obtain a credit report until after the consumer receives the disclosures.
In addition, the Fed proposed barring lenders from paying mortgage brokers a fee that exceeds the amount the would-be borrower had agreed to in advance that the broker would receive.
The Fed also proposed banning certain practices, such as failing to credit a mortgage payment to a borrower's account when the company servicing the mortgage receives it. And it would prohibit a broker or other company from coercing or encouraging an appraiser to misrepresent the value of a home.