Better Late Than Never, Washington Tackles Subprime Problems

Fearing voter ire, lawmakers and regulators will close the barn door -- at least partway -- in response to the mortgage meltdown.

By Matthew Mogul, Associate Editor, The Kiplinger Letter

April 5, 2007

Washington will soon take several steps to prevent a repeat of the subprime lending crisis. With defaults rising and some lenders who went too far in issuing risky loans going out of business, lawmakers will hold public hearings to ask why more wasn't done sooner and to shed light on lax lending standards and allegations of abusive sales practices. They'll also look to clarify what role regulators should play in policing the $10.5-trillion residential housing market.

Banks and other lenders will try to head off action by arguing that they're already taking steps to tighten up. HSBC Bank, for example, has cut back on the second mortgages it issues, and Countrywide Financial is no longer offering mortgages with no down payments.

But regulators and lawmakers won't be swayed. Voluntary moves can too easily be rolled back by lenders during the next housing boom.

Though some legislation is likely, don't expect a bailout or a moratorium on loan payments to give struggling borrowers a breather. And even though lawmakers will take the lead in publicly addressing the issue, they'll leave most of the work to regulatory agencies to fix a slew of problems. For example:

• The Federal Reserve will play a bigger role in supervising the mortgage market by getting states to adopt its strict federal guidelines. Currently, a patchwork of federal and state regulations governs mortgage lenders. More than half the subprime loans made in 2005 were issued by mortgage originators, such as the now-bankrupt New Century Financial Corp., which answer only to state regulators, not to the Fed. A uniform body of rules will clarify what mortgage brokers and lenders can and can't do, while subjecting all of them to tougher federal rules. It's still unclear whether Congress will need to pass legislation so the Fed can expand its powers, or if the agency can do so under current rules.

• The Federal Trade Commission will step up enforcement efforts, especially when it comes to rooting out deceptive and misleading behaviors. The extra muscle may flow from a more aggressive reading of the Real Estate Settlement Procedures Act, which requires disclosure to consumers about the mortgage process and settlement charges.

• Mortgage giants Fannie Mae and Freddie Mac will likely offer some relief on the mortgages they buy and hold. At the behest of the Department of Housing and Urban Development, government-sponsored Fannie and Freddie, which together own or guarantee about 40% of the residential U.S. mortgage market, may move to extend the grace periods for introductory teaser rates or waive late fees.

Look for Congress to pass several bills that complement regulatory actions.

• Legislation to modernize the Federal Housing Administration is coming. The Depression-era agency, which guarantees low-interest loans for low- to middle-income home buyers, hasn't kept up with the times and therefore has lost market share to subprime specialists. A streamlined FHA will be able to cut through a lot of today's red tape and give it the flexibility to entice many of the borrowers that were attracted to subprime mortgage originators.

• The Home Ownership and Equity Protection Act will also be fine-tuned. HOEPA currently protects borrowers of high-cost loans, but Congress will move to retool and beef up the law so that more loans are covered by its consumer protection rules.

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