Critics say Fed's plan won't fix mortgage mess

WASHINGTON — The Federal Reserve on Tuesday proposed new mortgage-lending rules to protect consumers against fraud and deception, but consumer advocates said lenders could still make the kinds of bad loans that triggered the subprime-lending crisis.

The proposal includes measures specifically aimed at higher-cost subprime loans for people with weak credit, as well as broader rules that would apply to all home loans.

It would require lenders who make subprime loans to consider borrowers' abilities to make payments and to verify that they have the income and assets they claim.

Consumer activists said the plan moves in the right direction but not enough. For example, borrowers who suspect their lender broke the rules would have to prove "a pattern or practice" of abusive lending, noted Kurt Eggert, a law professor at Chapman University and member of the Fed's Consumer Advisory Council.

"To prove what the lender's real policy is, a borrower would have to examine potentially hundreds of loan files, while the lender would be screaming about privacy for other borrowers," Eggert said. "This could be an insurmountable burden."

As of late November, more than 7.2 million families held subprime loans, with an outstanding value of $1.3 trillion. About 14 percent of holders of subprime loans are in default or behind on payments. That number is expected to surge next year when many adjustable-rate loans issued in 2006, when lending standards were weakest, reset to higher prices.

"Mortgage-market discipline has in some cases broken down, and the incentives to follow prudent lending procedures have, at times, eroded," Fed Chairman Ben Bernanke said. The proposed rules, he said, aimed to prevent improper lending without "unduly restricting mortgage credit availability."

The Fed proposal was released Tuesday for a three-month public-comment period, after which the Fed could adopt it with or without revisions.

For all loans, mortgage brokers would be required to disclose in writing if they receive bonuses for selling loans at interest rates that are higher than what a borrower qualifies for.

But critics — who deride such incentives as kickbacks — say the disclosures are easily overlooked or ignored in a mountain of other loan documents.

"Unsophisticated borrowers may be too easily convinced to take out a loan" with unreasonable charges and those bonuses, and the proposed rules wouldn't solve that problem, said John Taylor, president of the pro-consumer National Community Reinvestment Coalition.

He added: "A borrower shouldn't need to be a lawyer or financial expert to protect themselves from unfair and deceptive lending that leaves them vulnerable to foreclosure."

Experts Tuesday said some of the Fed proposals were helpful, such as the rule that lenders must verify income and assets for subprime loans. The proposal came in response to lenders offering "no-documentation" loans, and charging a premium for them.

Some borrowers used these loans to buy homes for speculative purposes, betting on rising prices. Others say they were lured into mortgages they did not fully understand. Now, with home values falling, many of these borrowers are facing foreclosure.

Criticism over the Fed initiative seemed certain to energize Democrat-led efforts in Congress to approve stricter requirements next year.

"We now have confirmation of two facts we have known for some time," said Rep. Barney Frank, D-Mass., chairman of the House Committee on Financial Services. "One, the Federal Reserve System is not a strong advocate for consumers, and two, there is no Santa Claus."

Information from McClatchy Newspapers is included in this report.