Tuesday, July 08, 2008

Fed Prevents Last Failure

The Fed announces new rules on lending practices that, if implemented a decade ago - would have prevented the mortgage 'crisis'.

To prevent a repeat of the current mortgage mess, Bernanke said the Fed will adopt rules cracking down on a range of shady lending practices that have burned many of the nation's riskiest "subprime" borrowers — those with spotty credit or low incomes — who were hardest hit by the housing and credit debacles.

The plan, which will be voted on at a Fed board meeting on Monday, would apply to new loans made by thousands of lenders of all types, including banks and brokers.

Under the proposal unveiled last December, the rules would restrict lenders from penalizing risky borrowers who pay loans off early, require lenders to make sure these borrowers set aside money to pay for taxes and insurance and bar lenders from making loans without proof of a borrower's income. It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the home's value.

For what it's worth, I actually don't have an issue with the last item.  Much of the mess, as I understand it, was caused by the mistaken belief that housing prices never - or perhaps can't - fall.  Allowing buyers to take out loans without even asking them to state income or asking them how they plan to repay the loan was the worst sort of negligence.

As for the rest, most of it appears to be relatively minor meddling, though I'm not overly thrilled with it.  Of course, the devil is in the details.  What is a "risky" borrower?  And why does the government get to decide whether I have to escrow my taxes or save for them on my own?

The one open question is what will prohibiting early payoff penalties do to the market?  Are these penalties common?  Are they only imposed on certain classes of borrowers?  Will the inability to collect these penalties push rates higher to cover the loss or will additional closing fees be added to collect the penalty from every borrower instead of just those that pay off early?

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