News Article From Federal
Reserve Press Release
Governor Randall S. Kroszner
Legislative proposals on reforming mortgage practices
Before the Committee on Financial Services, U.S. House of
Representatives
October 24, 2007
Chairman Frank, Ranking Member Bachus, and members
of the Committee, I appreciate the opportunity to appear before you
today, to discuss recent problems in the subprime mortgage market,
Federal Reserve actions that address these developments, and
potential legislative responses. Promoting access to credit and
sustainable homeownership are important objectives, and the Board
believes that responsible subprime mortgage lending can help advance
both goals.
Background
Subprime mortgages are loans intended for borrowers who are
perceived to have higher than typical credit risk. In recent years,
the subprime market has grown dramatically because of advances in
credit scoring and underwriting technology, which enables lenders to
charge different borrowers different prices on the basis of
calculated creditworthiness. These loans are recognized by the
higher prices they carry, which reflect subprime lenders' decisions
to seek additional compensation for the credit risk they incur.
As the overall mortgage market has grown, many new
lenders and distribution channels have developed and most of those
are outside the direct jurisdiction of the federal banking
agencies. A review of data provided by mortgage lenders pursuant to
the Home Mortgage Disclosure Act reveals that lenders that are not
subject to oversight by a federal banking agency originated just
under half of the higher-priced conventional first lien mortgage
loans reported in 2006.
While the expansion of the subprime mortgage
market over the past decade has increased access to credit, the
subprime mortgage market during recent years was also accompanied by
a deterioration in underwriting standards. In some cases, abusive
or fraudulent lending practices resulted in homeowners taking on
mortgage obligations they could not afford, with terms they may not
have fully understood. Delinquencies and foreclosures have
increased. During the past two years, serious delinquencies among
subprime adjustable-rate mortgages (ARMs) have increased
dramatically, reaching nearly 16 percent in August, roughly triple
the recent low in mid-2005. For so-called near-prime loans in alt-A
securitized pools (those made to borrowers who typically have higher
credit scores than subprime borrowers but still pose more risk than
prime borrowers), the serious delinquency rate has also risen, to
3 percent from 1 percent only a year ago. These patterns contrast
sharply with those in the prime-mortgage sector, in which less than
1 percent of loans are seriously delinquent.
Higher delinquencies have begun to show through to
foreclosures. About 320,000 foreclosures were initiated in each of
the first two quarters of this year (just more than half of them on
subprime mortgages), up from an average of about 225,000 during the
past six years. Foreclosure starts tend to be high in states with
stressed economic conditions and to rise where house prices have
decelerated or fallen. Adjustable-rate subprime mortgages
originated in 2006 have performed the worst, with some of them
defaulting after only one or two payments (or even no payment at
all). Relative to earlier vintages, more of these loans carried
greater risks beyond weak borrower credit histories--including very
high initial cumulative loan-to-value ratios and less documentation
of borrower income.
The recent increase in delinquencies and
foreclosures has created personal, financial, and social distress
for many homeowners and communities. We encourage servicers of
securitized mortgages to reach out to financially stressed
homeowners. Keeping families in their homes is a matter of great
importance to the Federal Reserve. In fact, the twelve Federal
Reserve Banks are working closely around the country with community
and industry groups dedicated to reducing homeowners' risks of
foreclosure. Each of the Reserve Bank community affairs offices
provides significant leadership and technical assistance in this
area.
I am also pleased to serve as the Federal
Reserve's representative on the board of directors of NeighborWorks
America, which has a program to encourage borrowers facing mortgage
payment difficulties to seek help by making early contact with their
lenders, servicers, or trusted counselors. NeighborWorks' Center
for Foreclosure Prevention Center recently launched a national
advertising campaign to raise awareness about its 24-hour national
hotline that connects struggling borrowers with homeownership
counselors. Since the launch of the campaign this past June, the
daily call volume has almost doubled from 1,000 to almost 2,000
calls a day.
The Board's Response to Problems in the
Subprime Market
The Federal Reserve has primary rule-writing authority for many
consumer protection laws. Consumer protection laws take two
complementary approaches to consumer protection: one focuses on the
provision of information, and the other involves the development and
enforcement of rules against abusive practices. The Board believes
it is extremely important to strike the right balance by seeking to
protect consumers from predatory lending practices without
restricting credit from responsible lenders to borrowers with
shorter or lower-rated credit histories. To achieve that balance,
we coordinate with other federal and state agencies, and consult
with consumer advocates, lenders, investors, and other interested
parties.
Consumer protection regulations
The Board believes it is important to provide
consumers with pertinent and accurate information. Clearly,
information is critical to the effective functioning of markets. A
core principle of economics is that markets are more competitive,
and therefore more efficient, when accurate information is available
to both consumers and suppliers. When information on alternatives
is readily available, product offerings must meet customers' demands
and offering prices must reflect those of market competitors. If
consumers are well informed, they are in a better position to make
decisions that are in their best interest. As a result, a
significant component of the rule-writing process involves crafting
disclosure requirements that provide consumers with consistent and
relevant information about the terms and fees of financial products.
To be effective, disclosures must give consumers
information that they can readily understand at a time when the
information is relevant. To that end, the Federal Reserve will
propose improvements to the rules governing the disclosure of
mortgage loan terms and conditions and the timing of those
disclosures. We will soon begin an extensive consumer testing
process to ensure that the new disclosures we propose will be
comprehensible and useful to borrowers. To further improve
consumers' access to meaningful information, we are also developing
proposed changes to the Truth in Lending Act (TILA) rules to address
concerns about incomplete or misleading mortgage loan advertisements
and solicitations, and to require lenders to provide mortgage
disclosures more quickly so that consumers can get the information
they need when it is most useful to them.
The Federal Reserve is keenly aware, however, that
disclosure alone may not be sufficient to combat abusive practices.
In addition to providing consumers with better information, the
Federal Reserve plans to exercise its rulemaking authority under the
Home Ownership and Equity Protection Act (HOEPA) to address unfair
or deceptive mortgage lending practices. We plan to propose rules
by the end of this year that would apply to subprime loans offered
by all mortgage lenders. We share the concerns of Congress that
certain lending practices may have led to the problems we are seeing
in the subprime market today. We are looking closely at practices
such as prepayment penalties, failure to offer escrow accounts for
taxes and insurance, stated-income and low-documentation lending,
and the failure to give adequate consideration to a borrower's
ability to repay.
To ensure that any new rules will protect
consumers without inappropriately reducing access to credit, the
Board has obtained input from a wide variety of interested parties.
I chaired a full day hearing in June that yielded valuable insight
from both industry and consumer groups. The Board also solicited
written comments from the public on the practices discussed at the
hearing. The Board received nearly 100 comment letters, and staff
is closely examining the issues raised and discussing possible
remedies. Other federal and state agencies have been consulted as
part of our efforts under HOEPA. We have also sought the views of
our Consumer Advisory Council, which advises the Board on matters in
the area of consumer financial services. The council's members
represent the interests of consumers, communities, and the financial
services industry.
Coordinated enforcement of consumer protection
laws
Enforcement of consumer protection measures is
also critical to protecting consumers from irresponsible or
predatory lending. Indeed, the consumer financial services laws
implemented by the Federal Reserve contain a number of substantive
protections, reflecting carefully considered judgments by Congress
that certain practices should be restricted or prohibited. The
Federal Reserve enforces these rules through oversight of the
institutions it examines for compliance with consumer protection
laws and regulations.
The regulatory scheme for the mortgage industry
has become extremely complex as the breadth and depth of this market
has grown over the past decade and the role of nonbank mortgage
lenders, particularly in the subprime market, has increased. As I
mentioned previously, data collected under the Home Mortgage
Disclosure Act show that independent mortgage companies made about
half of higher-priced mortgages in 2006. In addition, there has
been an increased presence of mortgage brokers, often independent
entities who take loan applications and shop them to depository
institutions or other lenders. These market developments have
resulted in mortgage lending extending beyond the federal banking
agencies' oversight, and this underscores the importance of
collaborating with the state banking agencies and other
organizations to address concerns in the subprime mortgage market.
To this end, we have launched a cooperative pilot
project with other federal and state agencies to conduct reviews of
non-depository lenders with significant subprime mortgage
operations. The reviews will evaluate the companies' underwriting
standards and senior-management oversight of risk-management
strategies for ensuring compliance with consumer protection laws and
regulations. Our partners in this initiative are the Office of
Thrift Supervision, the Federal Trade Commission, and state agencies
represented by the Conference of State Banking Supervisors (CSBS)
and the American Association of Residential Mortgage Regulators (AARMR).
At the conclusion of the reviews, the agencies will analyze the
results and determine whether to continue the project and, if so,
how to focus future reviews.
Loss mitigation efforts
The Board also has worked with the other federal
financial agencies to guide federally supervised institutions as
they deal with borrower mortgage default. In April 2007, the
federal financial institution agencies issued a
Statement on Working with Mortgage Borrowers (20 KB PDF).
The statement encourages federally regulated institutions to
work constructively with residential borrowers at risk of default
and to consider prudent workout arrangements that avoid unnecessary
foreclosures. In cooperation with CSBS, the federal financial
agencies issued a
Statement on Loss Mitigation Strategies for Servicers of
Residential Mortgages (21 KB PDF) in September 2007 to
address subprime and other mortgage loans that have been transferred
into securitization trusts. The statement calls on servicers of
securitized mortgages to review the governing documents for the
trusts to determine the full extent of their authority to
restructure loans that are delinquent or in default or are in
imminent risk of default.
To the extent possible, efforts should be made to
avoid foreclosure. We encourage servicers to reach out to
financially stressed homeowners, to make every effort to keep them
in their homes. Lenders and servicers, for example, may be able to
assist troubled borrowers by modifying the loan, deferring payments,
extending the loan maturities, converting an adjustable-rate
mortgage to a fixed-rate or fully-indexed loan, or capitalizing
delinquent amounts. The best outcome is a loss mitigation strategy
that results in a mortgage obligation that the borrower can meet in
a sustained manner. The use of these and other loss-mitigation
techniques is consistent with the interagency guidance that
emphasizes the importance of prudent underwriting practices to help
ensure that borrowers can meet the terms of their mortgage
obligations and maintain homeownership.
Legislative Responses
Congress is appropriately concerned about problems in the mortgage
market. The Mortgage Reform and Anti-Predatory Lending Act of 2007
takes a comprehensive approach and is appropriately focused on the
more problematic practices in the subprime mortgage market. We
share Congress's concerns with these practices. As with
regulations, it is important that new laws carefully target lending
abuses without unduly restraining responsible lending. Getting this
balance right is particularly critical now, as many borrowers facing
rate adjustments may need to refinance into more affordable loans.
The Mortgage Reform and Anti-Predatory Lending Act
of 2007 would provide greater oversight and regulation of mortgage
brokers, an approach that has merit. A nationwide registration and
licensing system for all mortgage loan brokers would help limit the
ability of bad actors to move to a new state after having run afoul
of regulators in other states. The CSBS and AARMR have a promising
initiative to establish a national registry. It would be
appropriate for any new legislation to ensure that all individual
brokers are included in the same nationwide registry.
The Mortgage Reform and Anti-Predatory Lending Act
of 2007 also addresses concerns about loans made without
consideration of a borrower's ability to repay. The Board firmly
believes that lenders should give due consideration to a borrower's
ability to repay a loan, before the loan is extended. We and the
other regulators have emphasized this several times in a variety of
guidance statements on mortgage lending. This is also one of the
areas we are looking at in our revisions to the HOEPA rules. In
developing laws or rules to address repayment ability, the rules
must be specific enough so that creditors can determine whether
their practices are in compliance because legal uncertainty could
have the unintended effect of reducing credit options for
creditworthy subprime borrowers. At the same time, rules must be
flexible enough to allow creditors to consider the pertinent factors
and individual circumstances of particular consumers and to innovate
prudently and fairly.
The Mortgage Reform and Anti-Predatory Lending Act
of 2007 would require originators to present borrowers with loans
that are appropriate to the borrower's circumstances. In the case
of refinancings, the bill provides that the loan must provide a "net
tangible benefit" to the borrower. As I have discussed, the Board
supports the goal of ensuring that consumers do not receive
unaffordable and abusive loans. However, it is critical to
carefully craft such laws or rules to ensure that they do not
inappropriately reduce credit availability in the mortgage market,
to the detriment of consumers.
The Mortgage Reform and Anti-Predatory Lending Act
of 2007 would hold securitizers and loan purchasers ("assignees")
liable for the actions of mortgage originators. The securitization
market is critical to increasing the resources available to fund
home purchases and great care should be taken to ensure that
investors in the securitization market can quickly and accurately
assess and mitigate the risks, including the compliance risks, of
mortgages sold in this market. Such laws should be very clearly
delineated to ensure that they do not have a detrimental impact on
the ability of lenders to securitize loans. Specifically, assignees
must be able to conduct due diligence and determine whether an
originator has complied with the law, so that they can evaluate and
price for any risks.
Finally, the bill would enhance HOEPA's
protections by prohibiting abusive practices, such as prohibiting
the financing of single-premium credit life insurance. HOEPA's
points and fees trigger would be lowered and additional fees added.
These potential actions merit discussion, and we welcome the
opportunity to continue to work with congressional staff on these
and other provisions in new legislation.
Conclusion
The Board is engaged in several activities to assist consumers, and
continues to develop rules that will improve consumer disclosures,
address unfair or deceptive practices, and help consumers facing
default and foreclosure. We look forward to working with Congress
to enhance consumer protection laws while maintaining access to
credit. |
