The US Federal Reserve announced new mortgage lending standards today that are designed to address so-called deceptive business practices among lenders. Those measures include:
¶Bar lenders from making loans without proof of a borrower’s income.
¶Require lenders to make sure risky borrowers set aside money to pay for taxes and insurance.
¶Restrict lenders from penalizing risky borrowers who pay loans off early. Such ”prepayment” penalties are banned if the payment can change during the initial four years of the mortgage. In other cases, a penalty cannot be imposed in the first two years of the mortgage.
¶Prohibit lenders from making a loan without considering a borrower’s ability to repay a home loan from sources other than the home’s value. The borrower need not have to prove that the lender engaged in a “pattern or practice” for this to be deemed a violation. That marks a change — sought by consumer advocates — from the Fed’s initial proposal and should make it easier for borrowers to lodge a complaint.
“Rates of mortgage delinquencies and foreclosures have been increasing rapidly lately, imposing large costs on borrowers, their communities and the national economy,” Mr. Ben Bernanke, the Federal Reserve Chairman, said.
“Although the high rate of delinquency has a number of causes, it seems clear that unfair or deceptive acts and practices by lenders resulted in the extension of many loans, particularly high-cost loans, that were inappropriate for or misled the borrower,” he added.
Excellent. Markets around the world can feel confident again that the US Federal Reserve has rooted out the major mortgage lending problems confronting the US Economy and has the entire situation under control.
It is beyond shocking that deceptive lending practices like this even exist in the most "efficient mortgage market in the world" (according to a 2006 IMF Mortgage Market Survey). What's more shocking is that the Fed knew about these practices, had data attesting to their impact on rising rates of mortgage fraud going back to 2005, and did nothing about it until today.
And how do I know that, you ask? Well, the Fed's own economists put out an insightful summary of what went wrong in the current credit crisis and you can read it here:
The first draft of this report was published in October 2007. And in perfect hindsight, the economists concluded,
"Were problems in the subprime mortgage market apparent before the actual crisis showed signs in 2007? Our answer is yes, at least by the end of 2005. Using the data available only at the end of 2005, we show that the monotonic degradation of the subprime market was already apparent. Loan quality had been worsening for five consecutive years at that point. Rapid appreciation in housing prices masked the deterioration in the subprime mortgage market and thus the true riskiness of subprime mortgage loans. When housing prices stopped climbing, the risk in the market became apparent."
Now the US Federal Reserve would not be the first organization in history to have better hindsight than foresight, but shouldn't we expect them at least to move faster with policy controls when the global credit market is facing the second worst crisis in history? And if it takes the Federal Reserve 2 years to study market data and write a telling report more than three months after the crisis has hit, and 8 months more to digest and issue lending guidelines to restrict fraud in the mortgage marketplace, how long exactly will it take them to react when Hank Paulsen consolidates all financial regulation in their hands?
To me this story offers some important lessons that I do hope Congress recognizes:
1. Regulatory Consolidation is not a panacea. Consolidated beauracracies do not historically produce operational efficiency. Witness the Department of Homeland Security and the performance of FEMA during Hurricane Katrina.
2. Data is useless without people empowered to act. The Fed had ample data to control mortgage lending fraud and prevent the worst aspects of the current credit crisis and it either chose not to act or its internal governance is so poor that there was no mechanism in place to forecast non-monetary economic risks and make micro-policy adjustments.
3. More important than regulatory consolidation, Congress should review the operational procedures and data governance practices at the Fed itself. A GAO Audit of Fed operational procedures and internal, below the Board, decision-making would be a great start!
4. The Subprime Credit Crisis was preventable! The Fed had the data and they had the economic skills to use it. They proved today that they even had the regulatory mandate to affect the changes in lending guidelines necessary.
Congress, the US Public, and the world at large, have a right to know what took them so long to use their own data before we entrust that organization with even more regulatory responsibility.
From where I am sitting, the Fed really needs Data Governance.