U.S. tells lenders to crack down

As usual, a day late and a dollar short. The abuses that the blogosphere has been reporting about for years, finally get the attention of banking regulators.

U.S. banking regulators told mortgage lenders Friday to toughen standards for subprime home loans in a belated effort to end abuses that led to a surge in defaults and the highest foreclosure rate in five years.

Lenders, in most cases, should verify income levels instead of relying on borrowers' statements, the Federal Reserve, the Federal Deposit Insurance Corp. and other regulators said in guidelines issued in Washington. They also said banks should consider potential interest-rate increases when judging whether homebuyers can pay off loans.

"We clearly have a profound problem," FDIC Chairman Sheila Bair said Friday. "It is going to get worse before it gets better, and decisive action was required," she added. "Everybody was asleep at the switch."

The guidelines come too late to repair the growing crisis in subprime mortgages. Nor did the effort satisfy lawmakers, who want regulators to complement the guidelines with enforceable rules. While bank examiners can strong-arm banks with the recommendations, consumers can't file lawsuits based on them because they aren't laws.

The focus now turns to the Fed, which is reviewing whether there is a need to codify the standards. While central bank policymakers have preferred to rely on guidance and disclosures, Fed Governor Randall Kroszner said they will "seriously consider" using its rule-making authority to prevent abuses.

"The Federal Reserve must take the guidance, strengthen its protections" and turn it into rules that apply to all lenders, Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said Friday. "Subprime borrowers, who are disproportionately black and Hispanic, deserve strong protections."

Bair also put pressure on the Fed to act quickly in adopting regulations that "apply across the board." Friday's guidance applies to lenders overseen by federal regulators, not to mortgage brokers that write most subprime loans, she said. Those lenders are overseen by state regulators.

The Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators said in a statement that they will issue similar guidelines for state regulators "in the next two weeks."

Lenders and consumer advocates said Friday's guidelines went further than they expected and signal that regulators have determined that such loans are high-risk products for consumers that require standards and protections.

"The regulators stuck to their guns," said Allen Fishbein, director of credit and housing policy at the Consumer Federation of America in Washington. "The key point is that it requires a sound analysis of the borrower's capacity to repay."

Subprime loans are those made at higher interest rates to borrowers with weak credit histories or high debt burdens. Fraud increased and lending standards fell as Americans borrowed $2.8 trillion for home loans from 2004 to 2006, the largest mortgage boom of any three-year period on record.

Lenders should be able to "readily document" a borrower's salary by checking annual income statements, pay stubs and tax returns, according to the guidelines, which were released by the Fed, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration.

"Stated-income and reduced-documentation loans should be accepted only if there are mitigating factors that clearly minimize the need for direct verification" of the borrower's ability to repay, the regulators said. That phrase is, in effect, a warning to lenders to avoid low-documentation loans, consumer advocates said.

Mortgage Bankers Association Chairman John Robbins said the new guidelines will "constrain consumer credit choices." The Washington-based group, which represents the mortgage industry, also discouraged Congress from passing legislation that would subject lenders to "rigid underwriting standards and litigation risk," Robbins said in a statement.

The value of subprime loans fell 10.3 percent to $722 billion in 2006 from a record $805 billion in 2005, according to JPMorgan Chase & Co. Credit Suisse Group predicts that loans will fall as much as 60 percent this year.