Federal Reserve governors, unanimously proposed tough new consumer-friendly disclosure rules for mortgages and home equity loans last month, tackling one of the less-appreciated causes of the nation's deep financial crisis.
After 18 months of study and consumer testing, the Fed's division of consumer affairs proposed, and governors accepted, a change to how finance charges and the annual percentage rate would be calculated. They also proposed restricting some bonus compensation from lenders to those who originate loans.
The action by the Fed's Board of Governors, which requires a four-month comment period before becoming final, came as Congress is weighing an Obama administration proposal to strip the central bank of some of its regulatory authority over consumer credit products such as mortgages and credit cards. The administration favors giving those powers to a new Consumer Financial Protection Agency, which would have the sole mandate of protecting consumers from abusive practices such as the weakened lending standards that triggered a collapse of the housing sector. This crisis in mortgage lending quickly morphed into a global financial crisis.
Last month's Fed vote also came hours after the National Association of Realtors reported that sales of existing homes rose 3.6% in June, the third consecutive month of increasing sales. All regions of the country posted growth, and the percentage of distress sales fell to 31% from 33% in May.
This report provides further evidence that activity in the housing market is stabilizing and that price declines are slowing. The increase in home sales over the last three months was the fastest since May 2004 (in percentage terms) and the NAR reports that the share of distressed sales is declining. This report, along with recent data on housing starts, building permits suggests that we may have seen the bottom in home sales and housing construction.
Wall Street cheered the housing news.
The Dow Jones Industrial Average closed up 188.03 points to 9069.29, crossing the psychological threshold of 9,000. The S&P 500 finished up 22.22 points to 976.29, and the Nasdaq wrapped up the day with a gain of 47.22 points to 1973.60.
Under the Fed proposal, lenders or other originators of mortgages-such as mortgage brokers-would have to provide borrowers with clear one-page explanations of how adjustable-rate mortgages, like those that triggered the housing crisis, differ from fixed-rate products. They'd have to provide clearer examples of what borrowers' true costs would be, using the loans themselves rather than generic examples.
Lenders also would have to notify borrowers of payment changes 60 days beforehand, rather than the current 25 days. Similarly, for home-equity lines of credit, the notification period would be 45 days instead of 15.
Those moves are decidedly more consumer-friendly, giving borrowers more notice to adjust to pending changes and perhaps seek refinancing in the case of adjustable-rate loans.
The most controversial proposed change is restricting special compensation from lenders when mortgage brokers get borrowers into higher-priced loans when they qualified for lower rates. This bonus, called a yield-spread premium, was a factor in the explosion of sub-prime lending, which involved high-cost loans given to the weakest borrowers.
The National Association of Mortgage Brokers has defended these special commissions but it declined immediate comment on the proposed rule change, which expressly would prohibit steering consumers to higher-priced products in pursuit of personal gain.
During the comment period, the Fed will work to create similar disclosures at the Department of Housing and Urban Development, which has jurisdiction over the settlement documents involved in home purchases.
"It is a complex and comprehensive proposal, so I think an extended comment period is appropriate," Fed Chairman Ben Bernanke said.
More information on this will be available approx. November 2009