What the Fed isn't fixing

Two years after the mortgage meltdown started, the Federal Reserve finally released updates to its mortgage regulations on Monday, replacing rules that were so lax and ineffective that the Fed bears significant responsibility for the mortgage debacle and the larger financial fallout. Unfortunately, the Fed still hasn't gotten at many of the root causes of the problem. In the face of the collapse of IndyMac -- the second-largest thrift failure in U.S. history -- and the foundering of Fannie Mae and Freddie Mac, one expected more.

The new rules are heavy on regulating mortgage advertising and require income-verification for subprime borrowers. The rules also place some restrictions on when lenders can charge prepayment penalties and require escrow accounts for property taxes and homeowners insurance on some loans.

But the Fed failed to tackle one of the most important players in the subprime market: mortgage brokers.

The Fed's own report states that 60% of loans were originated through mortgage brokers in the last several years. The report candidly acknowledges that consumers "often are unaware, however, that a broker's interests may diverge from, and conflict with, their own interests." And yet the Fed left the brokers alone.

Particularly problematic has been the abuse of yield spread premiums, which gave brokers higher compensation for placing a consumer in a higher-interest, riskier loan. Instead of stamping out this perverse abuse, the Fed withdrew its proposal for even a modest rule requiring brokers to disclose whether they were getting a premium.

The regulations also fail to establish a fiduciary-duty standard for mortgage brokers, with common-sense requirements such as making reasonable efforts to secure a loan advantageous to the borrower considering all the circumstances; safeguarding and accounting for money handled by the borrower; acting with reasonable skill, care and diligence; and following all reasonable and lawful instructions from the borrower.

Study after study showed that from 55% to 61% of borrowers had a high enough credit score to qualify for traditional, fixed-rate home loans but were steered into riskier subprime loans. Why? In part because mortgage brokers were able to line their own pockets that way. Without adequate new regulations and broker duties, unscrupulous brokers will continue to get away with ripping off consumers.