WASHINGTON — Bankers and consumer groups are clashing in suggestions to the Federal Reserve Board about what it should include in a rule restricting mortgage practices.
On the one hand, bankers — who for the most part would prefer the Fed not write a rule, despite a promise from Chairman Ben Bernanke it will do so — want a narrowly tailored proposal that does little more than offer better disclosures on certain practices.
On the other, consumer groups are seeking a rule that would tighten underwriting standards, force lenders to include escrow for taxes and insurance, and ban or clamp down on a number of practices, including prepayment penalties and stated-income loans.
Though comment letters to the Fed were filed while problems relating to the credit market were only starting to emerge, both sides also used the credit crunch to make their case.
"It is clear that, left to police itself, the industry has done a poor job," Shanna Smith, the president of the National Fair Housing Alliance, said in an Aug. 15 letter. "It is high time for the Fed to step in and appropriately monitor the industry and restrict abusive practices."
But some in the industry continued to argue that rising delinquencies and foreclosures are not connected with poor loans, but just the regular credit cycle. An overly restrictive rule would only make things wore, they said.
"The vast majority of delinquencies and foreclosures are not related to particular loan terms or products, but are due largely to the same factors that have led to delinquencies and foreclosures historically: job losses, divorce, and medical problems," Bill Himpler, executive vice president of federal affairs for the American Financial Services Association, wrote in an Aug. 15 letter.
Mr. Bernanke has pledged that the Fed will write a rule by yearend under the Home Ownership and Equity Protection Act to rein in abusive lending practices, but officials at the central bank have offered no details on what type of rule they will come up with.
Individual banks said that a broad plan would upset the market and that the Fed should focus on increased disclosure.
"Regulatory actions that limit product choice or the availability of credit should be narrowly applied, recognizing that borrowers are best served by full disclosures of mortgage product features that allow for flexibility, choice and affordability," said Jeffery Polkinghorne, senior vice president and chief credit officer for JPMorgan Chase Bank's home lending division.
Consumer groups say stepped-up disclosure is not enough. They zeroed in on practices like prepayment penalties, which they said were unfair and trapped borrowers in bad loans.
Maude Hurd, the president of the Association of Community Organizations for Reform Now, said in an Aug. 13 letter that "the inclusion of prepayment penalties on any subprime loan, not just those with adjustable rates, is an abusive practice. They serve solely to benefit the investors while stripping homeowners of their equity or keeping them locked into an unnecessarily high rate."
Industry groups said prepayment penalties are not always bad and should not be banned entirely. Mark Tenhundfeld, director of the office of regulatory policy at the American Bankers Association, and Robert Davis, executive vice president and managing director of government relations for America's Community Bankers, wrote in a joint letter Aug. 15 that such penalties allow a borrower to receive a lower interest rate while giving a lender more confidence in the predictability of a loan's performance.
If the Fed does seek to ban prepayment penalties, Mr. Tenhundfeld and Mr. Davis wrote, the ban should apply only to refinances on hybrid adjustable-rate mortgages that have low fixed rates for a short time period, such as so-called 2/28 ARMs.
Critics have also targeted no- and low-documentation loans as well as stated-income loans, where the lender does not verify a borrower's income. Though such loans are blamed in part for rising delinquencies and foreclosures, some industry representatives continued to defend their use.
"Prohibitions on stated-income or low-doc loans would impair the ability of these consumers to obtain mortgage credit," wrote Anne Canfield, executive director of the Consumer Mortgage Coalition. "Such prohibitions also would prevent borrowers (prime and nonprime) from benefiting from inexpensive streamlined refinances, often offered at competitive prices, to borrowers who appear poised to pay off a loan."
Federal regulators have already cracked down on the use of stated-income loans. In guidance released June 29, regulators said such loans could be accepted only in special cases, such as when a borrower whose financial situation has not changed is refinancing.
In an Aug. 15 letter to the Fed, Michael Calhoun, the president of the Center for Responsible Lending, said stated-income loans have no legitimate purpose for any but a narrow category of borrowers.
"The failure to document borrower income is highly deceptive under federal and state standards," Mr. Calhoun wrote. "Mortgages made without documentation of borrower's income are rife with deception."
He said the Fed should seek to restrict underwriting practices. "To re-establish a stable marketplace for lenders and consumers, a return to common-sense underwriting is needed to drive out unfair and deceptive practices that ensnare borrowers," he wrote.
The National Association of Attorneys General also called for stronger underwriting standards, and said at the Fed at the very least should extend the recent subprime guidance governing hybrid subprime mortgage products to all mortgage lenders, not just banks and thrifts.
"It should be a fundamental principle that no lender or broker should put a borrower in any home loan that the borrower does not have a realistic capacity to repay," the group wrote in a Aug. 13 letter, which was signed by 42 attorneys general.
At its June 14 hearing on the issue, Fed officials asked for comment on whether lenders should be required to underwrite all loans at the fully indexed rate and whether there should be a presumption that a loan is unaffordable if the borrower's debt-to-income ratio exceeds 50%.
Bankers were opposed to any rule that would cap the debt-to-income ratio at 50%, but they were more flexible on underwriting at the fully indexed rate.
"There may be times, however, when it is appropriate to make an ARM loan when the borrower is likely to be able to refinance the loan at a lower rate before the reset date," Mr. Tenhundfeld and Mr. Davis wrote. "Thus, any general rule should provide flexibility to permit exceptions as warranted."
The Fed has also sought comment on whether it should require lenders to escrow for taxes and insurance for subprime mortgages.
While several bankers outright opposed any mandate, several others said the Fed should set such a requirement only for first-time homebuyers purchasing subprime loans or for borrowers with high loan-to-value ratios.
Michael Heid, division president of Wells Fargo Home Mortgage, part of Wells Fargo Bank NA, said the Fed should require escrows for first-lien payment shock loans and certain other loans.
The Mortgage Bankers Association said there is no need for an escrow mandate. It said 50% of subprime mortgages overall and 71% of first-lien subprime mortgages have escrow accounts and predicted that the proportion of escrowed accounts will grow.
"We believe a requirement to establish such accounts in the first place treats borrowers as unable to take responsibility for their expenses," wrote John Robbins, MBA's chairman.
But an Aug. 15 letter from 44 California consumer groups, argued that a borrower with debt stretching their financial resources can be pushed over the edge by unexpected additional costs for property taxes and insurance.
"By failing to include the prorated monthly costs of taxes and insurance in that [loan] calculation, borrowers overestimate their own ability to repay the loan," the groups wrote.
