WASHINGTON - A much-anticipated hearing on the Federal Reserve Board's authority to curb abusive lending felt almost like an academic debate, particularly when compared to the events that preceded it.
The nearly eight-hour hearing at the central bank's headquarters here came just one day after the Fed was vilified in Congress for standing by while millions of people took out loans they either did not understand or could not repay.
But if Fed officials were feeling any pressure, it was not evident at Thursday's forum.
Acting as moderator, Fed Gov. Randall Kroszner and other central bank officials lobbed questions to lenders and consumer activists on escrow accounts, prepayment penalties, and low-documentation and no-documentation loans. But throughout the hearing, Mr. Kroszner maintained his neutrality toward new rulemaking.
Stationed at the center of a long table that separated consumer activists from industry representatives, he told the audience that regulators must "walk a fine line."
"We must determine how we can help to weed out abuses while also preserving incentives for responsible lenders," he said. "A robust and responsible subprime mortgage market benefits consumers by allowing borrowers with limited credit histories to become homeowners, access the equity in their homes, or have the flexibility to refinance their loans as needed."
The hearing came a day after a tongue-lashing from House Financial Services Committee Chairman Barney Frank, D-Mass., who said the Fed has not done enough to protect consumers. He expressed doubt about Mr. Kroszner's consumer-friendly credentials at a consumer protection hearing on Wednesday. "You reinforce my position that the Fed is not the best place for consumer protection," he told Mr. Kroszner.
Senate Banking Committee Chairman Chris Dodd continued the criticism Thursday, accusing the Fed of "foot-dragging" and urging it to act quickly.
"The Federal Reserve has a clear duty … to extend substantive protections to subprime borrowers, as my colleagues and I have outlined numerous times," Sen. Dodd said in a press release.
Consumer advocates at the Fed hearing, which was held to determine whether it could issue rules under the Home Ownership and Equity Protection Act to rein in the mortgage market, also blamed the central bank.
"I will say candidly that the Federal Reserve bears some responsibility for this," said Martin Eakes, the chief executive of the Center for Responsible Lending. "Congress required the board to prohibit acts that were unfair or deceptive. It wasn't a request. It was a mandate."
Representatives from banks and mortgage companies cautioned against any impulsive rule issuance. If the Fed must issue a rule, the bankers said, it should apply equally to all lenders.
"Wells Fargo believes guidance is more important than rules," said Susan Davis, an executive vice president at Wells Fargo Home Mortgage. "Any action taken by the board should be designed to create uniform standards."
The witnesses first sparred over whether tax and insurance costs should be included in escrow when people prepare to buy a home.
"The lack of including tax and insurance on that payment tells people your payment is going to be lower," said Ira Rheingold, general counsel of the National Association of Consumer Advocates.
But Faith Schwartz, the senior vice president of enterprise risk management and public affairs at H&R Block's Option One Mortgage Corp., countered that banks are simply providing a service by giving borrowers the option to exclude taxes and insurance from their escrow payment. "At the end of the day, there are reasons some people don't want escrow," she said. "Not everyone is cash-strapped."
Ms. Schwartz acknowledged that subprime borrowers should pay the full cost of escrow but stopped short of calling for a rule on the issue. "I believe in guidance," she said.
But Pablo Sanchez, the national mortgage production executive at JPMorgan Chase & Co., pressed further and urged the Fed to require full escrow payments for first-time homebuyers.
"It's absolutely the right thing for the first-time buyer," he said.
Without agreeing on the Fed's course, Mr. Kroszner shifted the debate to prepayment penalties and asked whether the central bank should issue a broad rule that would ban the practice.
Bankers argued that consumers can benefit from lower interest rates if they choose loans with prepayment penalties. But Mr. Rheingold called the practice "cynical" and said it should be banned. "I see no reason why prepayment penalties exist," he said.
Ms. Schwartz said the penalty is a tool to keep investors happy. "The purpose of a prepayment penalty can be to preserve investor certainty that money stays on the books longer," she said.
Leonard Chanin, an associate director in the Fed's division of consumer and community affairs, questioned whether banning prepayment penalties would make loans more expensive.
"It's hard for me to believe that if you eliminate penalties there would not be some implication for pricing," he said. "It's hard to predict such things, but I would think there would be some fallout."
Ms. Schwartz agreed and said the yield required by investors would increase if prepayment penalties were eliminated.
Even the consumer groups acknowledged that interest rates would rise if the penalty were banned. "If you take one of the measures of cash flow away, there has to be some increase in the rate, or else the market isn't being efficient," the Center for Responsible Lending's Mr. Eakes said.
The witnesses also disagreed on how to underwrite loans with little or no documentation of income. Sandra Braunstein, the director of the Fed's division of consumer and community affairs, asked why the central bank should not ban such loans, given the technology available to verify income. Bankers did not directly answer the question but said common sense should be used when making these loans.
"What we have to do as a lender is make sure there is a reasonableness to get to a level of documentation that is right," said JPM's Mr. Sanchez.
Ms. Braunstein pressed for specifics on a reasonableness standard, but Mr. Sanchez said it should depend on the loan. "That's why we have underwriters," he said.
Wells Fargo's Ms. Davis sounded uncomfortable with Mr. Sanchez's vagueness. "If you're going to restrict stated- or low-income loans, it has to be tied to a bright-line test that can be implemented everywhere," she said.
She said she took out a stated-income loan for her house. "I did it for ease and convenience."
