By Jonathan Peterson
Times Staff Writer
March 22, 2007
"Current regulations are insufficient to protect consumers," the California Reinvestment Coalition and other groups said in an August 2006 letter to Federal Reserve governors, who were considering tougher lending standards. "We write with a sense of urgency," the letter added, citing the "rampant" spread of shaky loans.
A month later, the Fed and other regulators issued stricter lending guidelines. But observers were stunned that the rules excluded adjustable-rate mortgages with low initial teaser rates. These loans, with payments that adjust sharply higher after a year or two, are at the center of the mortgage meltdown that threatens to further weaken the housing market and perhaps the broader economy as well.
"Nobody was home," said Michael A. Stegman, a housing policy expert and director of policy at the John D. and Catherine T. MacArthur Foundation. "None of the regulators were home."
As real estate values galloped higher after 2000, lenders expanded the use of sub-prime loans with features that made homeownership possible for people who couldn't qualify for traditional loans.
Increasingly, lenders approved sub-prime loans with little or no proof of income. These "stated-income" loans comprised 39% of sub-prime loans last year, up from 26% in 2000, according to the Center for Responsible Lending, an advocacy group for borrowers.
Real estate industry professionals watched the trend toward easy-money loans with concern.
"It was very clear that the standards had deteriorated," said David A. Lereah, senior vice president and chief economist of the National Assn. of Realtors. "I'm not a lender though. I kept on saying to myself – I guess they know what they're doing."
As long as home values rose, the borrowers gained equity and could refinance easily. But as home values flattened out or declined, many borrowers couldn't get new loans – and couldn't make payments when their teaser rates expired.
That led to a rise in defaults, which weakens home values by putting bargain-priced foreclosed properties on the market.
In late 2003 and early 2004, the Fed's internal analysts noticed a deterioration of lending standards, creating a higher risk of defaults and foreclosures, according to Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee. At around the same time, the leadership at the Fed was encouraging the development of alternative mortgages, he said, including sub-prime loans and adjustable-rate mortgages.
"This crisis has been in the making for several years, and in my view, it has taken far too long for regulators to act," Dodd told the agency heads in a letter this week.
At a committee hearing today, Dodd plans to question banking officials – including representatives of the Fed, the Comptroller of the Currency, the Office of Thrift Supervision and Federal Deposit Insurance Corp. Although these agencies have distinct responsibilities, they often act together on major banking initiatives.
The Federal Reserve, which regulates national bank holding companies, declined to comment on its regulatory performance. Kevin Mukri, a spokesman for the Comptroller of the Currency, which oversees national banks and their subsidiaries, said the agency conducted "a very extensive program of consumer protections" within the national banking system.
Increasingly after 2000, community activists complained that new sub-prime loans often contained hidden costs, such as hefty penalties to pay them off early, and warned of large numbers of failures if home prices stopped rising.
"We were discussing this issue right in front of the Federal Reserve Board of Governors," recalled Malcolm Bush, president of the Woodstock Institute, a Chicago-based think tank, of a meeting of the Federal Reserve's Consumer Advisory Council in 2000. "They would have had to be blind not to know what was going on."
To critics, banking regulators tend to be more concerned about the industry they regulate than they are about consumers.
Two years ago, former New York Atty. Gen. Eliot Spitzer (now the state's
governor) launched an investigation into mortgage lending practices. But instead of backing Spitzer's demand for lending records from three national banks, the Comptroller of the Currency filed suit seeking to block the probe – claiming that the state prosecutor was poaching on federal turf.
In October 2005, a federal judge forced Spitzer to drop his investigation. Representatives of both Spitzer's office and the Comptroller of the Currency declined to comment on the matter, which remains under appeal.
"Spitzer was concerned about the consumers – and the federal regulators were concerned about the banks," said John Taylor, president of the National Community Reinvestment Coalition, which took Spitzer's side in the case.
Pointing to the turmoil that has enveloped the mortgage industry and endangered the U.S. economy, Taylor added: "If we do not hold the regulators – the people responsible for enforcing the laws – accountable, this kind of disaster is going to happen again."
Defenders of the regulators say they have acted prudently. Many point out that the emergence of looser standards and new types of loans have allowed many people – including members of minority groups – to attain homeownership, and with it, a ticket to the middle class.
"I think they've done everything exactly how they ought to," Thomas P. Vartanian, an attorney with Fried Frank and former general counsel of the Federal Home Loan Bank Board. "I don't think they've underreacted, nor have they overreacted."
As concerns about shaky loans grew, however, U.S. officials told lenders in September to consider borrowers' ability to pay their loans when monthly costs jumped, and also to ensure that consumers were given sufficient disclosures of the commitment they were signing up for.
Under pressure from Congress, regulators this month proposed adding such standards to all the high-cost loans, including the adjustable mortgages with low teaser rates.
Many mortgage lenders are not banks and do not fall under the direct supervision of federal banking authorities. Even so, federal loan cops can have a major influence throughout the marketplace.
Since September, for example, 28 states and the District of Columbia have moved to adopt the revised federal lending guidelines established last year.
California is not among those 28 states, but California Department of Corporations Commissioner Preston DuFauchard said he hoped to unveil a proposal by May that "essentially does adopt" the guidelines recently set forth by U.S. regulators.
"Hopefully, we'll be able to implement it shortly after that," he said.