More Action RE: Subprime Lending and Mortgage Regulation

At the end of June the five agencies that regulate federally chartered banks and their subsidiary lending corporations issued final guidance to those institutions regarding subprime lending, particularly the so-called exotic or non-traditional loans that are threatening to bring down those lenders who haven't already filed bankruptcy or shut their doors.

While they were called "guidelines," compliance with the new underwriting rules is, if not mandatory, at least highly recommended on the part of institutions under the supervision of the five agencies.** The problem is that federally regulated institutions represent only a portion of mortgage lenders and maybe an even smaller share of those that are involved in writing subprime mortgages.

Now the Office of Federal Housing Enterprise Oversight (OFHEO) has widened the applicability of these guidelines significantly. The agency, which has responsibility for overseeing the operations of the two privately owned but government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae made the guidance applicable to the loans they are permitted to purchase. On Friday the two GSEs issued letters to their lender customers setting forth a program to insure that they were buying only mortgages that conformed to the Interagency Guidance standards.

In a press release regarding the GSE letters OFHEO said that Fannie Mae and Freddie Mac have taken proactive steps to assure that (loan) sellers are clear as to what mortgages they will accept and reject. All mortgages sold to Freddie and Fannie with an application date on or after September 13 of this year must conform to the guidance but lenders are urged to put the new rules in place as soon as possible. The GSEs also said that their automated underwriting systems will soon be updated to support adherence to the Interagency Guidance.

OFHEO Director James B. Lockhart said, "These initiatives by the Enterprises support the guidance issued by federal and state financial regulators and will address most originators of mortgages, both regulated and unregulated. This is a significant step. OFHEO will continue to work with federal and state regulators and the Enterprises to assure conformance with both the Interagency Guidance and (and a more recently finalized guidance regarding subprime lending) the Subprime Statement. These actions reinforce the necessity for safe and sound underwriting practices, which serve the interests of lenders and borrowers in promoting sustained homeownership."

Also on Friday General Electric (GE) announced that it was getting out of the subprime mortgage business and that it has already rid itself of $3.7 billion in loans, about 75 percent of its total portfolio, to reduce its exposure to the volatile market. The decision to quit underwriting in the subprime market was made during the second quarter and the loan sales resulted in a loss of $182 million for GE's WMC Mortgage unit.

Earlier in the year WMC Mortgage laid off more than 460 employees and took a $500 million charge due to the sale of part of its subprime assets.

WMC was one of over a dozen lenders named when Moody's Investors Services downgraded nearly 400 securities last week.

Several Republican lawmakers introduced a lending reform bill on Thursday. The sponsors, Representative Spencer Bachus of Alabama, ranking member of the House Financial Services Committee and two Ohio Congresspersons, Paul Gillmor and Deborah Pryce presented The Fair Mortgage Practices Act as the culmination of a 16 month effort to find a bipartisan solution to what is perceived as unfair practices within the subprime lending industry.

The bill would require mortgage lenders to be licensed and would set up a national registration system. The legislation would also prod lenders to pay closer attention to a borrower's ability to repay the loan, simplify disclosures to make them more transparent to borrowers, require preloan counseling would mandate escrow accounts for taxes and insurance and restrict prepayment penalties.

Reaction to the legislation thus far is mixed. The National Association of Mortgage Brokers has endorsed the requirement for a national registration system; they have been very critical of systems which do not include federally chartered institutions. The Mortgage Brokers Association declined comment on the basis they are reviewing the legislation, and at least one consumer group called the bill too weak.

It is hard to know what the mortgage world will look like when all of this shakes out in six months or a year. But at least lending, especially subprime and predatory lending is finally under the microscope. It is about time.

** The Federal Reserve, Office of Thrift Management, Federal Deposit Insurance Corporation, Office of Comptroller of the Currency, and the National Credit Union Administration.