Fed eyes rules for mortgage lenders

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Federal Reserve Chairman Ben S. Bernanke yesterday said the central bank is considering issuing nationwide regulations against abusive mortgage lending practices, but he cautioned that regulatory overkill could make it difficult for people to buy, sell and refinance homes.

"The Federal Reserve could set rules for all mortgage lenders" to prevent the loose lending practices and abusive sales tactics that have led to sharply higher defaults and foreclosures recently, he told the Joint Economic Committee, but the Fed is moving cautiously because such rules could misfire.

The Fed itself currently does not have authority to enforce nationwide rules that would apply to the majority of lenders that are not banks under the Fed's jurisdiction, he said. The law is enforceable only by private rights of action or citizen lawsuits, so any general rules or principles laid out by the Fed could make lenders subject to the widespread threat of civil lawsuits, he said.

"We would be setting up lenders for the uncertainties ... and would be probably killing the market because there would be so much legal uncertainty associated with lending in this market," he said. "Therefore, we have to make the rules extremely precise."

Mr. Bernanke downplayed the impact the mortgage crunch is having on the housing market and overall economy. His upbeat assessment caused a drop in financial markets yesterday as it indicated the Fed is not prepared to cut interest rates any time soon, with the Dow Jones Industrial Average falling 97 points to 12,300.

The Fed thinks "the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency," he said.

Several legislators at the hearing vowed to go after abusive lenders through legislation. Mr. Bernanke said that is worth considering, but advised them to be careful. While nationwide standards for lenders are needed, as it is a better way to enforce the rules once they're in place, he said, Congress should not do anything to stifle the credit that is the lifeblood of the housing market.

"The question of whether you want to go to a federal predatory lending law -- I think it's worth looking at that," he said. "There are a number of questions that would have to be answered. One would be: Would it be a pre-emptive law or would it be a base law" that the states could build upon. "And the second question to which you allude is: Who would enforce it?"

Some House Democrats are considering making investors who buy substandard mortgages in bulk partly liable for abusive practices that lead to defaults, but Mr. Bernanke pointed out that was tried in Georgia and led to a pullback in the availability of mortgages there.

"I think we do need to be somewhat careful," he said. "The best place to apply these rules would be at the level of the originator ... the balance is between maintaining a healthy access to capital in this market versus making sure that these rules are obeyed."

Mr. Bernanke said the riskiest loans appear to have been made in the last year as the housing market slowed sharply and lenders scrambled to qualify buyers for high-priced homes.

"A large increase in early defaults on recently originated subprime variable-rate mortgages casts serious doubt on the adequacy of the underwriting standards for these products."

Regulatory "guidance" that the Fed issued to banks at the beginning of last year appeared to have no effect in stymieing those loans, he acknowledged, though many states moved to adopt the guidance and said they would apply it to nonbank lenders.

Despite the substantial problems that have emerged in the subprime mortgage market where default and foreclosure rates are soaring, Mr. Bernanke said the trouble in the mortgage market does not appear to be spreading to the broader housing market.

"Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear. The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes."

Committee Chairman Sen. Charles E. Schumer, New York Democrat, said he has heard from New York dealers who sell pooled mortgages to investors that default problems are starting to creep into the prime market.

"The wave of subprime foreclosures that we have seen so far is just the tip of the iceberg," he said. "In many ways, I believe that the layering on of the risk in the subprime market reflects the layering on of risk in our broader economy."

Record-high debt levels and trade imbalances have left the country in a position where "the rest of the world could foreclose on us," he said.