Congress is eyeing tougher standards for risky, higher-interest home loans made to people with blemished credit records as defaults surge and lenders to the so-called subprime market see their own financing dry up.
Some analysts and executives said lawmakers and regulators missed earlier opportunities to scrutinize the mortgage industry, and they worry that a belated overreaction could make matters worse by choking off funds to the poor and further weakening the housing market.
Lawmakers “did nothing while the industry created this problem,” said Christopher Whalen, a New York-based managing director for Institutional Risk Analytics, which analyzes the risk level of companies. “Now,” he added, “the Congress is going to come out and start wringing their hands and looking for scapegoats.”
Whalen and others said the government has looked the other way for years as risky loans were made to consumers with shaky financial histories and interest rates were kept at historic lows, fueling speculative real estate investments.
“It’s a big issue because the chickens are coming home to roost and the very loose credit policies that we’ve had are now resulting in a great increase in foreclosures,” said Rep. Paul Gilmor, R-Ohio, adding that it is too soon to say whether new laws or tighter regulations are the best approach to the problem.
On Tuesday, the Mortgage Bankers Association said late mortgage payments shot up to a 3½-year high in the final quarter of last year and new foreclosures surged to a record high as borrowers with tarnished credit histories had trouble keeping up with their monthly payments.
The association reported that the percentage of payments that were 30 or more days past due for all loans tracked jumped to 4.95 percent in the last three months of 2006.
The House subcommittee that oversees financial institutions is scheduled later this month to hold a hearing on the mortgage industry’s turmoil. Executives from subprime lending firms could be called to testify at future hearings, congressional staffers said.
Rep. Carolyn Maloney, D-N.Y., who chairs the House Subcommittee on Financial Institutions and Consumer Credit, plans to introduce a bill that would impose more restrictive mortgage guidelines, including a requirement that lenders consider the ability of a borrower to pay back an adjustable-rate loan over the entire term — not just at the beginning, when “teaser” rates are extremely low.
“You can’t hand out loans that people can’t repay,” Maloney said. “It’s bad for the consumer and bad for business.”
Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee, said in a statement Tuesday that he is “considering a number of options, including legislation” to protect consumers from abusive lending practices and help consumers who have been harmed to maintain their homes.
Rep. Spencer Bachus, R-Ala., who drafted an anti-predatory lending bill last year based on North Carolina and New Jersey laws, called reforms to mortgage practices a “nonpartisan” issue. He noted that lawmakers were close to completing a bill last fall before negotiations broke down in a dispute about whether fraud victims should be allowed to file class-action lawsuits.
Also Tuesday, Treasury Secretary Henry Paulson, in an interview on CNBC, said it “shouldn’t be a surprise to anyone that there’s some fallout in the subprime mortgage market,” given the slowdown in the overall housing market. “It is largely contained.”
Earlier this month, the five federal agencies that regulate banks, thrifts and credit unions called on lenders to exercise caution in making subprime loans and to closely evaluate borrowers’ ability to repay them. Consumer advocates, meanwhile, say mortgage lenders should be required to determine whether a particular loan is suitable for a borrower before they issue it.
For its part, the mortgage industry plans to resist new regulations, which would be tantamount to “permanent disenfranchisement of a potential group of borrowers,” according to Kurt Pfotenhauer, senior vice president for government affairs at the Mortgage Bankers Association.
The market for subprime mortgages has exploded over the past 12 years, from fewer than 5 percent of all new mortgage loans in 1994 to an estimated 20 percent as of the first half of last year.
Talk of new restrictions on lenders comes as home-mortgage delinquencies and foreclosures are soaring, raising concerns about the potential impact on the broader economy.
Now home prices are falling in many markets as inventories rise, and the stock prices of companies that make high-risk loans are plummeting, rattling major stock market indexes. The Dow Jones industrial average fell more than 240 points on Tuesday as woes in the subprime market mounted.
Major banks cut off credit this week to New Century Financial Corp., a prominent subprime mortgage lender that on Tuesday announced it is the target of a Securities and Exchange Commission investigation into accounting errors that inflated the value of the company’s loan portfolio. Also on Tuesday, shares of Accredited Home Lenders Holding Co. sank to a new low after the company said it needed help raising money as the value of its loans sinks.
Two weeks ago, mortgage giant Freddie Mac said it would no longer buy loans for which borrowers qualify based on teaser rates that are held low for two or three years — a common practice in the subprime market. Instead, Freddie will require lenders to consider whether a borrower can make their mortgage payment when the teaser period is over.
Joseph Mason, associate professor of finance at Drexel University’s LeBow College of Business, said attempts to ban specific kinds of mortgages would likely fail because the financial industry will find new ways to offer similar products. As investors in risky loans back away, he said, much of the problem will correct itself.
Still, the industry’s troubles, he said, are a reminder that consumers need to be wary of saddling themselves with mortgages they do not understand.
“These mortgage brokers are sales people,” Mason said. “They are not your buddy or your pal.”
