WASHINGTON — A bill by House Financial Services Committee Chairman Barney Frank to revamp mortgage standards would leave the Federal Reserve Board off the list of regulators that would write rules to implement it, according to financial services and consumer advocacy representatives given a sneak peek this week.
Mortgage regulations traditionally fall predominantly under the central bank's bailiwick, but observers said its decade-plus deliberation over crafting lending rules covering the entire market might have jeopardized its power.
The bill, which Rep. Frank plans to sponsor along with two North Carolina Democrats, Reps. Brad Miller and Mel Watt, is still a draft and likely to change when the committee considers it. Nevertheless, observers said the plan to leave the Fed out of the rule-writing process seemed like a political statement. Several people wondered if the omission would survive to the bill's enactment.
"This reflects frustration many Democrats have with the way the Fed has used its existing regulatory authority, but ... it's much easier to implement changes with the Fed involved," said Jaret Seiberg, an analyst with Stanford Group. "It's pretty rare to strip an agency of its implementation and oversight authority for a particular regulation, so it seems such a radical change would be difficult to approve and tough to implement."
As problems in the subprime mortgage market unfolded over the last year, lawmakers have singled out the Fed for not putting forth standards for all lenders under the 1994 Home Ownership and Equity Protection Act. The Fed finally announced in July that it would issue such rules this year, but critics have argued that the current problems could have been averted had the Fed exercised its power to create a universal set of mortgage standards.
The legislation, which is expected to be introduced any day and is scheduled for debate in the committee next week, has captivated the attention of the entire mortgage market. It would entail a massive rewrite of the nature of lending with restrictions on the types and ways in which loans are made. It would affect everyone from originators down to securitizers that package loans on the secondary market.
Broadly, the bill would put a larger class of loans under HOEPA's high-cost protections. It would prohibit originators from steering consumers into loans by removing links between loans and compensation, including yield-spread premiums. Penalties for failing to abide by the standard could include three times brokers' fees and regulatory enforcement.
In addition, the bill would require all mortgage originators to be licensed and registered and borrowers to meet an ability-to-pay test. For the secondary market, the bill would create limited liability, which is being referred to as "securitizer liability," since it would end at the securitizer that packaged the loan and not extend to trusts or investors at the end.
For months industry and consumer representatives have participated in several rounds of closed-door briefings with key Financial Services staff members working with only bare-bone summaries of the bill.
On Wednesday, select financial services trade groups and consumer and civil rights organizations were allowed to preview a draft bill. Though both sides continued to praise the open process, they raised a host of concerns and said they would reserve judgment until they could have a copy of the final bill to examine more carefully.
The exclusion of the Fed from the list of rule-writing agencies — the other three federal banking regulators and the Federal Trade Commission would be given that power — was the biggest surprise to observers and brought assorted speculation.
Oliver Ireland, a partner with Morrison & Foerster LLP and a former Fed attorney, said the exclusion may not be purposeful. If the underlying bill amended other laws regulated by the Fed, such as the Truth-in-Lending Act and the homeownership law — as the bill is expected to do — lawmakers could be presuming it is implicit that the Fed has standing authority to make rules under such laws, he said.
However, the omission also could signal a threat to peel some of the Fed's power back, Mr. Ireland said. "If you were amending TILA, to not have the Fed be a rulewriter you might have to have to take away rule-writing authority that the Fed already has."
Also, the Fed's reputation for taking a free-market approach on banking policy is unappealing to lawmakers who believe the market went too unregulated, he said.
"Sometimes people don't like what [the Fed's] economists say, because economists tend to think markets are going to work, and people who want legislative solutions or regulatory solutions... as opposed to market solutions, don't want to hear that kind of input," he said.
Another lobbyist said the exclusion of the Fed's voice on market functions would create incentives for lobbyists to push for clearer definitions in the bill rather than leaving them up to regulators to draft.
"Let's make sure all the right regulators are there.... The Fed has an expertise that would be beneficial," the lobbyist said.
Many of the groups who have been working intimately with staff members on the bill said that they viewed the move as an obvious slap intended to embarrass the Fed, but that they expected the agency would ultimately be given rulemaking too.
"It's the chairman's way of sending a message that 'We don't appreciate that you have not been responsive.' … It allows the discussion to occur on record in the committee," one industry lobbyist said.
Michael Calhoun, the president of the Center for Responsible Lending said the omission is "probably stemming from the 'Use it or lose it' comment that Mr. Frank made earlier in the year."
John Taylor, the chief executive of the National Community Reinvestment Coalition, said "It's important that the Fed be part of the enforcement structure, because they regulate financial institutions that the other agencies don't."
A Fed spokesman said, "We will be reviewing the bill and offering the committee the Board's views."
Steve Adamske, a Rep. Frank spokesman said it's "premature" to draw conclusions about the bill.
The bill's impact remains an open question. Industry trade groups said they needed to consult further with their members before taking public stances, though some privately called the bill "workable" and said it was not as onerous as they feared.
Consumer groups said that even though they generally support the bill's intention to eradicate predatory practices, the penalties for lenders or securitizers who break the rules do not go far enough.
Mr. Calhoun and Mr. Taylor said the proposed penalties for securitizers were not steep enough to stop risky loans.
"It may be that the penalty could be taken as a cost of doing business for some in the industry," Mr. Taylor said.
Mr. Calhoun agreed. "There are lots of obstacles to helping a family who has been victimized by predatory lending, and that's essentially the trade-off they made in the bill," he said.
"They have some substantial limitations on prepayment penalties and a ban on yield-spread premiums, so they are trying to change the market and at the same time reassure both lenders and the secondary market that they are not going to create liability that would be either costly or disrupt the flow of capital. Our concern is that the current line is pushed too far towards limiting the remedies in assignee liability."
