A banking regulator has warned Congress that the mortgage market will get worse before it gets better and offered proposals that can help improve the situation.
The comments were made yesterday before the U.S. Senate's Committee on Banking, Housing and Urban Affairs yesterday by Sheila C. Bair, chairman of the Federal Deposit Insurance Corporation, according to a transcript of her prepared testimony.
"Problems surrounding unaffordable mortgages are acute in today's environment," Bair said. "I believe things may get worse before they get better."
She described the use of covered bonds, where banks issue general obligation bonds that are secured by a pledge of loans that remain on the bank's balance sheet.
"Proponents argue that covered bonds provide an additional source of funding for mortgages while providing stronger incentives for sound underwriting practices than securitizations," Bair testified.
But she said the market for covered bonds was hampered by uncertainty about how they would be handled when a bank becomes insolvent. FDIC addressed this by issuing guidance in April clarifying how they would be treated in the case of insolvency and establishing safeguards to permit the prudent and incremental development of a covered bond market.
Bair explained that the guidance indicated covered bond issuances must be made with the approval of the bank's primary regulator and that total covered bonds be limited to four percent of an institution's total liabilities.
"Importantly, the collateral for the covered bonds must be secured by perfected security interests under applicable state and federal law on performing mortgage loans on one- to four-family residential properties, be underwritten at the fully indexed rate and rely on documented income in accordance with existing supervisory guidance governing the underwriting of residential mortgages," she said. "The FDIC's guidance should permit the development of a covered bond market in a way that permits bank supervisors to evaluate the growth and risks of this funding mechanism."
The FDIC chairman touched upon her proposed plan Home Ownership Preservation Loans, where the government would provide $50 billion to pay down 20 percent of an existing mortgage so the loan-to-value would leave the borrower in a better position to refinance.
Bair also noted the FDIC has submitted a comment letter to the Federal Reserve Board about concerns the agency has with proposed amendments to Regulation Z.
Among recommendations made was the implementation of a standard that would require lenders to determine a borrower's ability to repay a loan and a prohibition of underwriting based only on the initial teaser rate for all high-priced and nontraditional mortgage loans. In cases where debt-to-income ratios exceed 50 percent, the agency recommended a disclosure be provided to borrowers and investors.
FDIC also called for a ban on the use of prepayment penalties, yield-spread premiums and stated-income underwriting on high-priced mortgages as well as a prohibition on stated-income nontraditional loans. It also said a proposed requirement that borrowers on high-priced loans maintain escrow accounts for taxes and insurance for at least 12 months be extended for a longer period.