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Calhoun Statement: Federal Regulation of "Exotic" Mortgages

Friday, September 29, 2006

Federal financial regulators took a step toward making the mortgage market safer for borrowers today, although there is still much more they can do.

Alarmed by a huge increase in new types of mortgages with monthly payments that can make huge leaps, causing "payment shock" to families, regulators will now require lenders to consider whether a borrower can afford these types of home loans.

That means fewer homeowners in the future will wind up losing their homes to the banks through foreclosure.

The securities business already requires stockbrokers to consider whether investors can afford their products. It is high time mortgage lenders were held to the same standard. Reckless lending by some lenders has endangered perhaps millions of homeowners who took "exotic" mortgages; created the risk of a crash in the housing market; and perhaps even a recession, creating the possibility of untold misery.

The Office of the Comptroller of the Currency, the nation's main federal bank regulator; the Board of Governors of the Federal Reserve System; the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, the Treasury Department and the National Credit Union Administration said Friday that lenders must tighten the standards by which they make loans.

But the Center for Responsible Lending has some warnings about places where the regulators did not go far enough.

The first and most important: Regulators missed an entire area of the market that could also blow up on borrowers. The federal agencies should expand their scrutiny from mortgages that are negatively amortizing – that is, when the borrower's monthly payment is lower than the interest due, and the loan balance increases rather than decreases with every payment – to this much broader piece of the mortgage market.

That piece is more conventional sub-prime adjustable-rate mortgages, or ARMs, whose initial payment rate can jump by as much as half – even if market interest rates do not change. They are known as "exploding ARMs," and like the negatively amortizing loans, lenders have pushed them on borrowers by flourishing low, introductory "teaser" rates that can eventually blow up.

Secondly, the regulators also say lenders must consider incentives for loan officers to make the best kind of loan to a borrower and not push option adjustable-rate-mortgages simply because they are often more profitable for the bank. The Center for Responsible Lending urges regulators and banks to do more to ensure this happens.

Third, this regulatory guidance, as it's called, which will be used by regulators in regularly examining lenders, does not apply to state-regulated mortgage companies that make loans but don't take deposits.

The agencies said they would work with regulators of these companies to set the same standards. It is important they do: Almost two-thirds of the loans in the sub-prime market, where people of modest means and with weaker credit ratings borrow, are not subject to regulation by the federal regulators who issued these guidelines today.

Finally, the center calls on lenders and the Wall Street firms that buy these loans from them to work with borrowers trapped in loans with payments they can't afford. The industry pushed these loans; now it has a duty to help borrowers avoid losing their homes.

To be sure, the Center for Responsible Lending, a nonprofit that does research and works to stop predatory lenders, applauds these regulators for adopting these guidelines putting the financial health of consumers first.

The standards the regulators set today are a good first step. Among them: Requiring banks to consider whether a borrower can repay the regular full rate under the terms of the loan, not just the lower "teaser" rate that entices borrowers into these loans; and in an attempt to curb overstating of borrowers' income by lenders and brokers, the regulators would require them to independently verify the borrower's income that the brokers and lenders enter on the loan documents.

But all these loans, not just the ones the regulators propose to supervise more closely, are complicated, hard for consumers to understand and easy for unscrupulous lenders and brokers to foist on customers. And – when sold to the unwary borrower – they are potentially harmful products that could plunge borrowers into financial woes, put their homes at risk, and even hurt the broader economy.

That is why today's statement from the regulators is important. But let us not stop here. The lenders, the regulators, the consumer groups and consumers themselves must all do more to make sure mortgages are bought and sold wisely and fairly.

For more information: Kathleen Day at (202) 349-1871 or kathleen.day@responsiblelending.org; Sharon Reuss at (919) 313-8527 or sharon.reuss@responsiblelending.org; or Ginna Green at (510) 379-5513 or ginna.green@responsiblelending.org.