WASHINGTON — Philosophical divides among regulators on how to root out issues that led to subprime mortgage problems came to a head at a House Financial Services Committee hearing Wednesday as agency principals split on support for reform legislation.
Comptroller of the Currency John Dugan and Office of Thrift Supervision Director John Reich said certain aspects of a bill from House Financial Services Chairman Barney Frank were overly broad and subjective and would cut off legitimate lending.
"The more stringent underwriting standards for subprime mortgages would by definition restrict the availability of credit to subprime borrowers more than the federal banking agency standards," Mr. Dugan said.
But Federal Deposit Insurance Corp. Vice Chairman Martin Gruenberg, who testified on behalf of Chairman Sheila Bair, voiced strong support for the legislation, saying the bill could go further.
"The proposed bill provides a workable and helpful vehicle for legislative action to establish proven underwriting standards for bank and nonbank lenders," Mr. Gruenberg said. "Certain provisions of the bill would help ensure that borrowers receive mortgages that they can ultimately afford to repay, and that lenders understand the risks of their credit decisions."
The agencies also were divided on whether the bill should preempt state consumer protection laws — a key element bankers are hoping to add. Mr. Reich said a single national standard would be preferable, but Mr. Gruenberg and Massachusetts Banking Commissioner Steven Antonakes argued that states should remain free to enact their own legislation.
"The approach taken in the bill as introduced of setting a floor by establishing a national minimum … [standard] is a reasonable approach," Mr. Gruenberg said.
Mr. Antonakes quickly agreed. "We would like the states to have the right to address specific issues," he said.
But Mr. Reich said one national standard that was sufficiently tough would be better. "I'd like to see a national standard with the bar high enough that it would satisfy all the states."
The hearing was the first airing for a bill that is the product of several months of collaboration among industry representatives, consumer groups, and regulators on ways to reform the mortgage market. The bill would impose specific minimum underwriting standards, including requiring lenders to ensure borrowers can repay and to act in their best interest. It also would hold the secondary market accountable for loans it securitizes by posing limited legal liability for failed loans that lacked certain underwriting standards.
Mr. Dugan, Mr. Reich, and Gov. Randall Kroszner of the Federal Reserve Board -- who largely stayed quiet during the hearing but seemed to share some of the other agencies' concerns about the bill -- said they were worried the bill's impact would go well beyond the subprime market and could upend legitimate lending.
The standards would "prevent some creditworthy borrowers from obtaining loans. The stricter standards also would prevent more existing subprime borrowers with adjustable-rate loans from refinancing such loans," Mr. Dugan said.
He and Mr. Reich raised other problems with the legislation. In particular, Mr. Dugan said, a provision that would require lenders to make loans in the best interest of consumers would be too subjective a standard.
"The federal duty of care and anti-steering provisions — which include highly subjective requirements that mortgages be 'appropriate' and 'in the consumer's interest' — will be difficult to enforce and could significantly increase the litigation exposure for all banks," he said.
Mr. Reich and Mr. Dugan also argued that banks and thrifts should be exempt from a provision that would require licensing for all mortgage originators, saying it would be duplicative for financial institutions.
"We question whether the burden of the licensing and registration requirements for all bank employees involved in any type of mortgage origination is, given existing bank regulation, worth the marginal benefit," Mr. Dugan said.
Mr. Reich endorsed a similar carveout for thrifts, saying that it would be "unnecessary and unduly burdensome" to force them to jump through such hoops.
He went further in seeking to give the OTS new oversight powers, arguing that the agency should share responsibility for nondepository mortgage lenders with state regulators. The bill calls for states to enforce the legislation's origination standards and says the Housing and Urban Development Department can intervene if state enforcement is weak.
But in a short interview outside the hearing, Mr. Reich said that the OTS would be a better fit for such a role.
"It would be a similar role that the FDIC has with state-chartered banks, where they rotate examinations of state-chartered banks each year," he said. "We might do the same thing with mortgage banks with the various states, depending upon the states' resources."
But the OTS lacks the resources to take on oversight of brokers, Mr. Reich said. "I'm not sure how many mortgage brokers there are in the U.S., but they number in the hundreds of thousands. That would take substantial resources, and we don't have those kind of resources."
Like Mr. Kroszner and Mr. Dugan, Mr. Reich also raised concerns about the bill's assignee liability provision, which would hold securitizers liable for a loan unless it met certain criteria.
"On the one hand, I think it is good for all the parties involved in the mortgage origination process to have skin in the game, and to have servicers have a responsibility … makes some sense," Mr. Reich said. "But I also have some concerns with the arguments that assignee liability has the potential for eliminating access to loans, particularly [to] low- and moderate-income people … and many of them have been able to demonstrate that they are able to handle their loans and make their payments."
However, Mr. Gruenberg — and, by proxy, Ms. Bair, who could not attend the hearing because of illness but submitted her comments in written testimony — praised the bill as a good solution for problems in the subprime market. The only suggestion the FDIC had was to explicitly address deceptive marketing materials by lenders.
The bill "should address misleading or confusing marketing that prevents borrowers from properly evaluating loan products," Ms. Bair urged in her written testimony. "The standards should require that marketing information for adjustable-rate mortgages include a benchmark comparison of the rate and payment being offered by the same lender for a traditional 30-year fixed-rate mortgage."
She also defended the bill's requirement that a loan's debt-income ratio should not exceed 50% — a standard that came under attack from Mr. Dugan and Mr. Reich.
"Establishing a rebuttable presumption of affordability based on a debt-to-income ratio of less than 50% will help ensure that borrowers will be able to afford their home loan payment," wrote Ms. Bair.
But Mr. Reich said such a formula was too simplistic.
"You might have a 51% debt-to-income ratio, but you might have assets in addition to your income from which you intend to repay your loan," he said in the interview. "The underwriting ought to be left up to the industry and to the regulators."
Though Rep. Frank's bill appeared to enjoy the support of most House Financial Services Democrats, several Republicans said they opposed it at a morning briefing with reporters. "I'm concerned anytime Congress starts to dictate underwriting standards," said Rep. Jeb Hensarling, R-Tex.
But Rep. Frank brushed off their concerns, saying that other Republicans are likely to support the bill, and that conservative GOP members would oppose any substantive reform. "In the end, do I think I'm going to have a bill that Hensarling and [Tom] Feeney and [Scott] Garrett will vote for? No."
