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Cascade: No. 68, Spring/Summer 2008

The Federal Reserve System’s Response to Subprime Mortgage Challenges

The issue of rising foreclosures across the nation was addressed by Sandra F. Braunstein, director of the Division of Consumer and Community Affairs of the Federal Reserve System’s Board of Governors, at the reinventing older communities conference. In light of high foreclosure rates, the Federal Reserve is using its full range of powers – supervising and regulating banking institutions, writing and enforcing regulations, and directing monetary policy to stabilize markets – to mitigate the current foreclosure crisis and to address issues of concern in mortgage lending that will help prevent a recurrence of the current situation.

Immediate Responses

The Federal Reserve has undertaken a number of initiatives — immediate, near-term, and long-term — in response to the foreclosure crisis. One immediate goal is to identify ways to assist delinquent borrowers and help them remain in their homes when possible. Toward this end, the Federal Reserve has engaged key industry participants to discuss responses to the current crisis and, along with other regulators, has issued guidance strongly urging lenders and servicers to assist borrowers by adopting a range of loss-mitigation options, including refinancing, loan modifications, forbearance, and short sales. In a recent speech, Federal Reserve Chairman Ben S. Bernanke proposed that lenders could engage in principal writedowns under some circumstances, such as when homeowners owe more on their mortgages than their homes are worth, which may be less costly for lenders than foreclosure.1

Through its community affairs offices at the Board and the 12 regional Banks, the Federal Reserve is collaborating with regulators, community groups, policy organizations, and public officials to identify local strategies that help homeowners and communities prevent or mitigate the effects of mortgage delinquencies and foreclosures. According to Braunstein, since May 2007 community affairs offices have sponsored more than 50 foreclosure-related events with nearly 5,000 attendees.

By making data and other research resources available, the Federal Reserve hopes to help organizations make decisions that will benefit borrowers and local communities. Braunstein noted that Neighbor- Works America used data from the Federal Reserve to identify areas of greatest need for the allocation of $130 million in congressional funds that the nonprofit received to increase housing counselor capacity.

She also explained that the Federal Reserve has provided data analyses and maps that show regional variation in the condition of securitized owner-occupied subprime and alt-A mortgage loans.2 This information can help community organizations, policymakers, and local governments identify the areas that are most vulnerable to foreclosure by showing areas with high foreclosure rates, large shares of loans that are 90 or more days’ delinquent, and high proportions of adjustable-rate mortgages (ARMs) that are scheduled to reset in the next 12 months.

Near-Term Responses

Sandra F. Braunstein of the Federal Reserve Board of GovernorsSandra F. Braunstein of the Federal Reserve Board of Governors

Braunstein pointed out that there has been a significant increase in lending by nondepository mortgage lenders, institutions that fall outside the supervisory purview of the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corporation. To help provide insight into the policies and practices of such entities and their compliance with consumer protection laws and regulations, the Federal Reserve is participating in a multi-agency initiative that is conducting reviews of selected institutions. This pilot program is focusing on nondepository subsidiaries of bank and thrift holding companies, as well as mortgage brokers doing business with, or working for, these entities. Additionally, the state agencies participating in the program will conduct coordinated examinations of independent state-licensed subprime lenders and their associated mortgage brokers. The agencies will share information about the reviews and investigations, take action as appropriate, collaborate on the lessons learned, and seek ways to better cooperate in ensuring effective and consistent reviews of these institutions.3

The Federal Reserve is also concerned about housing vacancies in neighborhoods and the impact they have on communities. A large number of vacant homes, including real-estate-owned properties (REO) held by loan servicers, can result in a deterioration of a neighborhood’s property values or other negative effects, Braunstein observed. To establish an effective approach for the treatment of REOs, the Federal Reserve has partnered with NeighborWorks America to evaluate options such as rehabilitating homes for first-time homeowners, creating good-quality rental units, or selling homes to community land trusts to help promote neighborhood stabilization in communities with numerous foreclosures.

Long-Term Responses

Finally, the Federal Reserve has used its rulemaking authority to ban certain unfair and deceptive practices and to require that consumers receive disclosures earlier, in an effort to make the mortgage lending process more understandable to borrowers. On December 18, 2007, the Federal Reserve proposed new rules under the Home Ownership Equity Protection Act (HOEPA) and the Truth in Lending Act. The rules, if adopted, will apply to all mortgage lenders and not just to depository institutions.

The proposal is two-pronged. It would provide additional protection for higher-priced mortgages, but it also contains provisions that would apply to all home-secured loans. For higher-priced mortgages,4 the proposal would prohibit lenders from engaging in a pattern or practice of making loans without considering the ability of borrowers to repay and would require lenders to verify the borrowers’ income and assets that are relied on when making the loan. Lenders would be required to escrow property taxes and homeowners’ insurance (with the option for lenders of allowing borrowers to opt out after 12 months). The use of prepayment penalties in higher-priced mortgages would be restricted and the prepayment penalties would have to expire at least 60 days before the interest rate on the loan resets.

The proposal also includes new consumer protections that would apply to most mortgage loans. The proposal would require early disclosure to the borrower of a mortgage broker’s total compensation, and the lender would be prohibited from making payments to the broker that would exceed the disclosed amount.5 Loan servicers would be required to promptly credit payments to a consumer’s account and provide payoff statements within a reasonable period of time. Servicers would also be banned from pyramiding late fees. Under the proposed rules lenders and brokers would be prohibited from coercing or encouraging an appraiser to misrepresent the value of a home. The Federal Reserve has also proposed additional disclosure rules for mortgage advertising, and certain misleading or deceptive advertising practices would be prohibited, including the advertisement of ARMs as fixed-rate loans.

The Federal Reserve has reacted to this current foreclosure crisis by promoting a balanced mortgage market that supports access to mortgages, including responsible subprime loans, and a range of consumer options within the market. Its actions represent a constant balancing act between “enabling innovation and flexibility while ensuring meaningful consumer protections,” a point that Braunstein emphasized. She also noted that the Federal Reserve will monitor and continue to respond to unfolding events in the mortgage market.

  • 1 “Reducing Preventable Mortgage Foreclosures,” speech by Chairman Ben S. Bernanke, Independent Community Bankers of America Annual Convention, Orlando, Fla., March 4, 2008, www.federalreserve.gov/newsevents/speech/bernanke20080304a.htm. External Link
  • 2 “Dynamic Maps of Nonprime Mortgage Conditions in the United States,” www.newyorkfed.org/mortgagemaps. External Link
  • 3 See Federal Reserve press release, www.federalreserve.gov/newsevents/press/bcreg/20070717a.htm. External Link
  • 4 According to the rule, “higher-priced mortgages would be those whose annual percentage rate exceeds the yield on Treasury securities of comparable maturity by at least three percentage points for first-lien loans, or five percentage points for subordinate-lien loans.”
  • 5 A fee paid by a lender to a broker for a higher-rate loan is known as a “yield spread premium.”

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