Monday, March 5, 2007

Tougher rules pushed for subprime loans

Under mounting pressure from investors and consumer groups, federal banking regulators yesterday strongly urged lenders to tighten their standards for issuing subprime loans to home buyers.

Lenders must disclose more information about products such as adjustable-rate mortgages to people with poor credit histories and make sure borrowers are able to repay the loans, according to the new guidelines.

Edward Leamer, director of the UCLA Anderson Forecast, called the guidance a response by Wall Street to spiking foreclosure rates. Rising delinquencies have forced lenders to create larger reserves to offset their losses.

“I think people were encouraged to buy homes that they could not afford,” Leamer said. “It is unfortunate that the financial community supported those kinds of acquisitions. In a way, it is greed. I would say it was a desperate search for yield in a low-yield environment.”

A variety of consumer groups, including the Center for Responsible Lending and the AARP, recently asked regulators to set limits on adjustable-rate mortgages in the subprime market.

“The guidance restores some sound lending principles to the part of the market that has not had adequate regulatory standards,” said Paul Leonard, director of the lending center's California office. “It is a notice-and-comment guidance. We hope the regulators will enact it in permanent form as quickly as possible.”

While not a big player in subprime lending, mortgage giant Freddie Mac this week announced that it would tighten its policies toward subprime home loans.

Zoltan Pozsar, an economist for Moody's, said the guidance was expected by those who closely follow the lending industry.

“Subprime is perceived as increasingly risky,” he said. “The real risk in the near-term outlook is if we see some big investors getting hurt. That could lead to a lot of fear in financial markets about how big the problem is.

“Trading could freeze up; that is a very real risk. If trading stops, the funds stop flowing.”

Several financial companies that specialize in subprime mortgages have seen their share prices drop in recent weeks. Investors have been made even more nervous by the steep global stock-market losses this week, Pozsar said.

“This week was scary,” he said. “The U.S. is the epicenter of the subprime worry.”

G.U. Krueger, an Irvine economist who specializes in housing issues, said loose underwriting standards are a key issue.

“I think this is happening because some of the subprime loans turned into foreclosures or notices of default very quickly, especially during 2006,” Krueger said. “The standards may have been too loose for some consumers. Is subprime really that bad? I think there have been bad apples.”

Lenders had hoped for a less-strict proposal. John Robbins, chairman of the Mortgage Bankers Association, said his group was concerned that the guidelines “may restrict credit to many consumers in high-cost areas and deny credit to many deserving low-income, minority and first-time home buyers.”

Ed Smith Jr., government affairs chairman for the California Association of Mortgage Brokers, said federal regulators should carefully balance the need for tighter underwriting standards against the benefits that subprime loans provide to consumers in high-priced markets such as San Diego County. He noted that state lawmakers also are debating the issue.

If too many options are taken away from consumers, the guidance could help create “a subset of renters in California,” Smith said.

California home mortgage loans went into default last quarter at the highest rate in more than eight years, according to the DataQuick Information Systems research firm. Lenders sent notices of default, the first step in the foreclosure process, to 37,273 California homeowners during the fourth quarter.

In San Diego County, there were 1,621 foreclosures on residences during 2006, compared with 212 in 2005, DataQuick reported. Analysts say the impact has been minimal because foreclosures still represent only a small fraction of the housing market.

Locally, home prices have softened since the county reached a record median price of $517,500 in November 2005. The overall median home price was $472,000 in January, down 5.6 percent from a year earlier.

The proposed guidance was issued by the Federal Reserve Bank, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration.