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CHICAGO — The Federal Reserve is “currently undertaking a thorough review of all of its options under the law” to deal with subprime lending problems, its chief said Thursday, and it may use its rule-making authority to prohibit certain specific practices. He noted more buyers have entered the secondary market for subprime mortgages. Lending practices that are newly determined to be “unfair and deceptive” could be prohibited under the Home Owners Equity Protection Act, Fed Chairman Ben Bernanke pointed out in his speech that opened a Federal Reserve Bank of Chicago conference. And HOEPA regulations, unlike those set by the Fed, he noted, apply to all mortgage lenders.But any new rules that are issued by the Fed should be sharply drawn to prevent “legal and regulatory uncertainty” that could reduce legitimate subprime lending and subject lenders to private lawsuits for redress of HOEPA violations, he warned.
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But any new rules that are issued by the Fed should be sharply drawn to prevent “legal and regulatory uncertainty” that could reduce legitimate subprime lending and subject lenders to private lawsuits for redress of HOEPA violations, he warned.
Further use of the Fed’s HOEPA authority will be discussed at a public hearing next month, he added.
While criticizing the negative developments of the subprime lending business, he concluded, “The vast majority of mortgages, including even subprime mortgages, continue to perform well.”
But the problems of the subprime lending market must be evaluated and acted upon not only by the Federal Reserve, but also by other regulators and Congress who must then decide what additional regulations or oversight are needed to prevent a recurrence, Bernanke said.
“In my judgment, effective disclosures should be the first line of defense against improper lending,” he explained.
But combating bad lending practices, including deliberate fraud or abuse, may require additional measures, he admitted.
Steps financial regulators can take also include requiring more lender disclosures to borrowers, prohibiting “clearly abusive practices,” offering “principles-based guidance combined with supervisory oversight,” and working with industry participants to “establish and encourage best practices or supporting counseling and financial education for potential borrowers,” he explained.
But the “patchwork nature of enforcement authority in subprime lending” poses its own challenges, he said, and the Fed is committed to working closely with other regulators to achieve “uniform and effective enforcement.”
And although supervisory guidance applies only to banks and thrifts, it often is adopted by state regulators of nonbank lenders, he pointed out.
Some mortgage originators have contributed to subprime problems, Bernanke charged. As mortgage originations slowed while investor demand for securities with high yields remained string, they loosened their underwriting standards and engaged in risk layering.
“Intense competition for subprime mortgage business — in part the result of the excess capacity in the lending industry left over from the refinancing boom earlier in the decade–may also have led to a weakening of standards,” he said, according to a transcript of his speech.
“These looser standards,” he said at the conference, “were likely an important source of the pronounced rise in early-payment defaults.”
“Some originators had little capital at stake and did not meet their buy-back obligations after the sharp rise in delinquencies,” the transcript indicated he said.
However, some signs of self-correction in the subprime market are now occurring, Bernanke pointed out at the meeting, with lenders tightening underwriting and investors scrutinizing subprime loans more carefully.
“But although the supply of credit to this market has been reduced credit has by no means evaporated,” he commented.
Increased purchases of subprime loans by investment banks, hedge funds and other private capital sources are beginning to fill the void left by the decline in securitizations, he pointed out.
And while some subprime originators have gone out of business, he noted, others remain in operation after being purchased by large financial institutions.
“We see no serious broader spillover to banks or thrift institutions from the problems in the subprime market,” he stressed.
But delinquencies and foreclosures are likely to increase this year and next, he warned, “as many adjustable-rate loans face interest-rate resets.”
While Bernanke laid much of the blame for the subprime blow-up on loosened underwriting standards, Federal Deposit Insurance Corporation Chairman Sheila C. Bair placed some of the blame on the models used to determine subprime loan risk.
“Models can be flawed,” she said at the same conference. “Look at the models for subprime mortgages. The models didn’t look at situations where home prices would decelerate and interest rates would go up. A lot of models didn’t pick that up.”
