MercoPress. South Atlantic News Agency

Fed anticipates tougher regulations for mortgage market

Fed Dr. Randall S. Kroszner

Federal Reserve governor Randall Kroszner said this week that the central bank was forced to cut its benchmark interest rate in September because earlier attempts to increase liquidity did not help enough.

Kroszner also revealed the Fed will propose new regulations for the mortgage industry including lending standards and disclosure rules. Regarding inflation he said core inflation has moderated, but "there continues to be some price pressures". In a speech at the National Bankers Association 80th Annual Convention, in Durham, North Carolina, Kroszner said the central bank's decision to cut its key rate by half a percentage point came after previous attempts to deal with a credit crunch were not enough to return the financial markets to normal functioning. "At that time, we judged that a 50 basis point lowering of the target federal funds rate was appropriate to offset the effects of tighter financial conditions on the economic outlook and reduce the risks that a further tightening in credit conditions could impact the housing market and lead to significant broader weakness in output and employment". Prior to the reduction of the Fed funds target, which is known as the central bank's benchmark rate, the Federal Reserve had used a number of other techniques to improve liquidity and stabilize the financial markets. Shortly after the credit crunch became acute in August, the Fed injected funds into the system and lowered its so-called discount rate, the rate it charges to loan money to banks. In the question and answer portion of his presentation before bankers, Kroszner commented on inflation. "Some of the core inflation numbers that I tend to focus on have moved down gradually over the last six months to a year, but there's still some potential inflationary pressures going forward," he said. Kroszner also announced the Fed will propose new lending regulations by the end of this year, "that would apply to sub-prime loans offered by all mortgage lenders". The rules would address several factors that have gotten sub-prime borrowers into financial difficulties. Those include prepayment penalties that can make refinancing unaffordable, stated-income lending or so-called "liar loans", failure to require escrows for taxes and insurance, and lending to home-buyers who have no reasonable prospect of maintaining their payments over time. In addition to the new lending standards, the Fed is going to propose new disclosure rules and will soon begin consumer testing of various types of information that lenders will have to present to mortgage applicants about the terms and risks of their loans. In its regulations, Kroszner said, "it is extremely important to strike the right balance by seeking to protect consumers from abusive lending practices without restricting credit from responsible lenders to borrowers with shorter or lower-rated credit histories". The Federal Reserve and other US banking regulators have come under criticism in Congress and elsewhere for not doing more to prevent abuses in sub-prime lending. Former Chairman Alan Greenspan has conceded in recent interviews that the Fed knew of what he has called the "egregious activities" in the sub-prime market but did not recognise their full scope or the potential economic risks. Implicitly defending the federal banking regulators, Kroszner ran through a list of the "guidance" to lenders that they had provided on sub-prime and "exotic" mortgages going back to 1999. The regulators emphasised loan-to-value and debt-to-income ratios, credit scores, the risk of negative amortization and the need for mortgage securitizers to have back-up financing plans in place, he said. Non-bank, unregulated mortgage companies which accounted for almost half the new loans last year weren't affected by the "guidance," and now the federal and state regulators are working on ways to make sure all mortgage lenders are under the same standard.