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THE MORTGAGE MELTDOWN

Fed imposes new rules on lenders

Crackdown on verifying borrowers' creditworthiness aims to avert another mortgage crisis.

July 15, 2008|Maura Reynolds and Walter Hamilton | Times Staff Writers

WASHINGTON — The Federal Reserve clamped down hard on mortgage lenders Monday, issuing rules designed to curb the sorts of risky and deceptive lending practices that helped trigger the subprime mortgage crisis.

The Fed's action, although criticized by some for not going far enough, was widely seen as a crucial step in reasserting control over a financial market that had been allowed to run wild.

For The Record
Los Angeles Times Saturday, July 19, 2008 Home Edition Main News Part A Page 2 National Desk 1 inches; 38 words Type of Material: Correction
Mortgage lending rules: A July 15 article in Section A on new Federal Reserve rules for mortgage lenders, and an accompanying list, said the regulations would take effect Oct. 1. The rules go into effect Oct. 1, 2009.

"There's lots more to come," said Thomas Lawler, a former Fed official who is now a housing market consultant. "The pendulum is clearly swinging toward more regulation and more government involvement."

The central thrust of the new rules is to restore sound underwriting practices, such as requiring lenders to verify that borrowers actually have the income and assets to make their loan payments.

The regulations adopted Monday were significantly stiffer than draft proposals issued six months ago, reflecting regulators' intensifying concern over the fallout from the free-for-all lending that helped create the bubble in home values and led to the mortgage meltdown.

The government is stepping up efforts to prop up a housing market battered by loan defaults and foreclosures. Those efforts produced results Monday, as news of a government rescue plan helped mortgage giant Freddie Mac complete a closely watched $3-billion sale of debt.

The sale came a day after the Bush administration said it would seek congressional approval to temporarily boost the Treasury Department's lines of credit for Freddie Mac and fellow mortgage finance company Fannie Mae, and to take the rare step of investing in their stocks if necessary. The Fed also said it would extend loans to the companies.

The moves were designed to give Fannie and Freddie the cash they needed to buy mortgages issued by lenders and resell them to investors. Last week, shares of both companies lost almost half their value amid sudden concerns that the companies wouldn't have enough capital to withstand the mortgage downturn.

"They had no choice except to step into the breach," said Vincent Reinhart, a former Fed official now at the American Enterprise Institute for Public Policy Research. "The entities have gotten too big to fail and so they can't fail."

Tom di Galoma, head of U.S. government bond trading at Jefferies & Co., said there was "a tremendous amount of demand" for the Freddie Mac bonds, a sign that the companies "can weather any kind of near-term" concerns about their financial health.

The stocks of the two companies didn't fare as well. After surging higher in the morning on initial enthusiasm over the Treasury plan, Fannie shares fell 52 cents, or 5.1%, to $9.73. Freddie's stock declined 64 cents, or 8.3%, to $7.11.

Analysts said investors continued to head for the exits on fears that any investment in the companies by the Fed could further diminish the value of their holdings.

"There was a sudden realization that in the event these entities are bailed out, the equity of these firms will be worth basically nothing," said Jack Ablin, chief investment officer of Harris Private Bank in Chicago.

The moves marked the second time in four months that the Bush administration had waded deeply into the private sector with an emergency rescue package cobbled together over a weekend.

In mid-March, the Fed engineered a fire sale of stricken investment bank Bear Stearns Cos. to JP Morgan Chase & Co. after Bear Stearns was weakened by a run on the bank that threatened to send shock waves through the global markets.

Although investors were reassured by the Treasury plan for Fannie and Freddie, they also fretted that scores of regional banks around the country would not survive as they continued to be hammered by loan defaults. Those fears were amplified by the government's seizure Friday of IndyMac Bank, leading to a broad decline in banking stocks.

In adopting the new rules on mortgage lending, Fed Chairman Ben S. Bernanke traced the lenders' woes back to their own practices.

"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," Bernanke said in a statement.

The new rules take effect Oct. 1 and will apply to all mortgage lenders, brokers, servicers and banks, not just those already regulated by the central bank.

"These rules are a step forward in returning common-sense business practices to the subprime lending market," said Paul Leonard, director of the California office of the Center for Responsible Lending, a nonprofit advocacy group.

Subprime mortgages, designed for borrowers with low incomes or poor credit, carry above-market interest rates to compensate investors for the added risk of default.

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