Federal Reserve Board Gov. Elizabeth Duke put forth a broad roadmap Thursday for how the mortgage industry should look and operate in the future.

Duke stated the main question she had set out to answer at the Federal Reserve Bank of Chicago's conference on mortgage foreclosure policies: "How can the market reemerge with enough flexibility to allow more families to achieve homeownership in a responsible way, while avoiding the mistakes of the recent past?"

Four core principles — adequate consumer protection, transparency, simplicity and properly aligned incentives — are essential for officiating at the development of standards and a retooling of the lending system, she said.

Loan underwriting "has proven very difficult," she said, but added that she is hopeful the rules outlined by the Fed will change this.

"Our new rules require that lenders verify borrowers' abilities to repay these 'riskier' mortgages, ban prepayment penalties if payments may increase in the loan's early years, require escrows for taxes and insurance and prohibit a range of misleading advertising practices," Duke said.

Citing housing facts that illustrate the damage in the market, Duke said the number of active mortgage companies fell 25% from 2006 to 2008 and the number of mortgage applications in 2008, 14.2 million, was about half the 2006 total and the least in more than a decade.

"While defaults in 2007 and 2008 were elevated by poor underwriting practices and the use of inappropriate mortgage products, the current deterioration reflects to a greater degree job losses and lower house prices," she said, adding that Fed programs have helped to reduce default rates.

Moving forward, Duke said, restoring the residential housing finance market will require access to information, standardized contracts and simplified structures.

"Servicer contracts will need to provide clear guidance and incentive structures that lead to transparency and certainty in loan modifications and other loss-mitigation tools," she said, adding that servicers may need to enhance staffing levels and information technology infrastructure.

Regarding Fannie Mae and Freddie Mac, Duke said, "Market participants will need to see a clear roadmap for both the individual institutions and the role of government in housing finance before private markets can begin to map a course for themselves."

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