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These Fed hearings should be interesting...

Posted by: Dean Foust on May 30, 2007

In response to the firestorm of controversy over subprime loans – namely, that millions of financially unsophisticated borrowers Federal_Reserve.jpgwere put into mortgages they didn’t understand and couldn’t afford – the Federal Reserve will hold a hearing on June 14th under the Home Ownership and Equity Protection Act of 1994. Here’s a link to the release.

In the release, the Fed says it wants to solicit debate on such issues as:
• Prepayment penalties
• Escrow accounts for taxes and insurance on subprime loans
• “Stated income” or “low doc” loans
• Consideration of a borrower’s ability to repay a loan

Some of the questions that the Fed wants to discuss at the hearing are intriguing, including:

• Should prepayment penalties be restricted? For example, should prepayment penalties that extend beyond the first adjustment period on an ARM be prohibited? (My opinion? No and no.)

• Should stated income or low doc loans be prohibited for certain loans, such as loans to subprime borrowers? (My view: Yes.)

• Should stated income or low doc loans be prohibited for higher-risk loans, for example, for loans with high loan-to-value ratios? (Not in my opinion.)

• Should lenders be required to underwrite all loans based on the fully-indexed rate and fully amortizing payments? (Yes! Yes! Yes!)

• Should there be a rebuttable presumption that a loan is unaffordable if the borrower’s debt-to-income ratio exceeds 50 percent (at loan origination)? (Hmmmm. That's a tough one. I see arguments both for and against.)

One other nugget I found interesting was this: The Fed notes that “some consumer advocates stated that brokers and lenders should be held to a fiduciary standard such as a duty of good faith and fair dealing or a requirement that they make only loans that are suitable for a particular borrower….Fiduciary responsibilities would, in industry’s view, create conflicts for lenders, who are responsible to their shareholders.

Interesting that the mortgage lenders come out and say this – given our obligation to our shareholders, we don’t necessarily have an obligation to put you in the cheapest, or most appropriate, loan. Our primary obligation is to maximize profits for our shareholders.

Reader Comments


May 30, 2007 8:35 PM

When I was learning the securities business years ago, we were taught that the Fed controlled margin loans that were used to buy stock via Reg T. The Fed determined how much money could be loaned using stocks as collateral. The Fed determined the interest rate on margin loans.

How Model T is that thinking today? Now, hedge funds borrow all the money they want in Japan at no interest to buy derivatives that the Fed doesn't even know exist. The Fed is out-of-touch and definitely far away from any kind of control. The Fed really has become a relic.

The same is true of these stupid Fed hearings. The real story will take place in courts of law. The corruption and collusion of the mortgage and real estate industries will be put on trial in many venues, civil and criminal. The Fed has no jurisdiction or authority. It's amazing that so many intelligent people think the Fed can rescue the economy with rate cuts.

Jim D

May 31, 2007 10:45 AM

Since the banks (and the MBS suckers they sell to) seem utterly unable to guard against fraud with stated income loans, Congress should simply require that all loans backed by any statement of income be checked against a database of Federal Income Tax statements. There's little reason to allow these loans at all, and if someone is getting income that isn't on their tax return, that's Tax Fraud, by definition.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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