Viewpoint: Fed's Mortgage Move is a Good Start

With foreclosures reaching record levels and predictions for further trouble ahead, the Federal Reserve Board on Tuesday unanimously approved potentially sweeping changes to how mortgages are marketed, made, and serviced, especially in the nonprime market. Will the Fed be able to meet its goal of a "comprehensive set of protections to consumers" when the comments come flying?

The proposed revisions to regulations under the Truth in Lending Act are designed to realign relationships in the mortgage business, so borrower and lender are once again interested in the same result: a good mortgage.

The rules, unlike guidelines bank regulators issued over the last 18 months, would apply to all mortgage lenders and other participants in the process (such as brokers, independent mortgage bankers, and appraisers), not just banks, thrifts, and credit unions. That the Fed has proposed them at all is both an indication of how bad the situation has become and a testament to new leadership at the central bank.

The proposed regulations would, for a new class of "higher-priced mortgage loans" (meant to cover not only subprime but also the some part of the alt-A market), require lenders to lend based on the borrower's ability to pay at a fully indexed, fully amortizing rate, verified by independent third-party documentation. Escrows for taxes and insurance would be required (for at least the first 12 months the loan is outstanding), and prepayment penalties would have to expire at least 60 days before the first payment change.

The proposed regulations also respond, for all loans secured by a primary residence, to abuses in brokerage, appraisals, and servicing. Advertising abuses, such as calling a loan fixed when it's not, would be prohibited. Lenders would be required to provide borrowers with information about payments, finance charges, and interest rate early in the shopping process, and before charging any application fee.

There is plenty of room -- all of which will undoubtedly be taken in the 90-day comment period -- to argue with specifics in the proposal. Is the definition of "higher-priced loan" sufficiently broad, or too broad? Is 60 days enough time to refinance after a prepayment penalty ends, before a rate reset takes place? Do the proposal's safe harbors strike the right balance between providing creditors with a degree of certainty and not undermining the good intentions of the rule?

Randall Kroszner, the Fed governor most responsible for the proposal, said the Fed's goal "to protect borrowers from practices that are unfair or deceptive, but to do so without unintentionally causing responsible lending to shrink or unduly limiting consumer choice" was "challenging to perfectly achieve."

Issuing the final rule after receiving comments will be even harder. Now that the Fed has stepped up with a series of proposals that would affect all lenders, it's time for the good lenders to stop shielding the bad, and recognize that we need some new rules, badly.

As for Congress, if the Fed moves quickly it will beat the timetable for regulatory improvement that's in either the House-passed Mortgage Reform and Anti-Predatory Lending Act (which requires final regulations to be issued 12 months after enactment) or the bill Sen. Chris Dodd introduced Dec. 12 (six months). But the Fed has not eliminated the need for legislation.

There are areas the regulations have not touched, mostly because they are beyond the central bank's authority. These include nationwide licensing, testing and registration of mortgage brokers; liability -- beyond the initial creditor -- for violations of standards; requirements for pre-foreclosure counseling and modification attempts; and bankruptcy law changes to permit judges to modify home mortgage loans that are "underwater."

And the Fed can't provide the money needed for substantial increases in housing counseling, assistance to communities in trouble because of the foreclosure crisis, or even the enforcement of its own proposal by states and the Federal Trade Commission -- all essential if we're to minimize the damage the mortgage crisis still has in store for us. That's the job of Congress and state legislatures.

What the Fed did on Tuesday is a major move in the right direction. But there's still so much more to do.