March 22 (Bloomberg) -- The Federal Reserve could have acted faster to prevent a meltdown in the subprime-mortgage market by curbing the lax lending standards that contributed to the crisis, the Fed's chief bank supervisor said.

``Given what we know now, yes, we could have done more sooner,'' Roger Cole, the Fed's director of banking supervision and regulation, told the Senate Banking Committee in Washington today, as regulators testified for the first time before Congress on the market rout.

Lawmakers called the hearing after growing concern that the deterioration of subprime lending will spread to regular mortgages and even into the broader economy by cutting into consumer spending.

Committee Chairman Christopher Dodd, a Connecticut Democrat, pressed Cole and other regulators to explain whether supervisory and enforcement lapses helped lead to the turmoil in the subprime market that has driven delinquencies to a four-year high. The regulators said while they took some enforcement action, they placed the main responsibility on lenders to police themselves.

``I don't want this to go on any longer -- this has got to stop,'' Dodd said, urging the Fed to use its authority to end abusive lending. ``Regulators were supposed to be the cops on the beat, protecting hard-working Americans from unscrupulous financial actors. Yet they were spectators for far too long.''

Rising Delinquencies

Borrowers were late on more than 13 percent of subprime mortgage payments last quarter, the highest delinquency rate since September 2002, the Mortgage Bankers Association said last week. Delinquencies on all mortgages were the most since June 2003.

Subprime home loans are made to borrowers with poor or limited credit ratings or high debt burdens. Looser underwriting standards and slowing home-price gains left subprime lenders holding bad loans.

A regulator of the biggest U.S. banks said fraud contributed to the surge in delinquencies.

``It is clear that some subprime lenders have engaged in abusive practices, and we share the committee's strong concerns about them,'' said Emory Rushton, senior deputy comptroller in the U.S. Office of the Comptroller of the Currency.

Dodd called HSBC Finance Corp. Chief Executive Officer Brendan McDonagh before the committee and the panel also included executives from Countrywide Financial Corp., General Electric Co.-unit WMC Mortgage and First Franklin Corp. New Century Mortgage Corp., the second-largest subprime lender, refused to send a witness, according to Dodd.

`Be Careful'

Congress and regulators should ``be careful about an overcorrection'' that would further curtail access to credit for subprime borrowers, Sandy Samuels, executive managing director at Calabasas, California-based Countrywide, told the committee.

Laurent Bossard, CEO of Burbank, California-based WMC Mortgage, said his bank is improving its loan underwriting. WMC this month raised its minimum credit scores for mortgage applicants.

The Fed's failure to decisively act on early signs of trouble in subprime mortgage lending put 2.2 million borrowers at risk of losing their homes, Dodd said. Today's delinquencies are just ``the tip of the iceberg,'' said Senator Richard Shelby of Alabama, the committee's senior Republican.

Data collected by the Federal Reserve Board clearly indicated lenders had started easing standards by early 2004, Dodd said. He asked why the central bank didn't issue directives to banks that they ``make sure that the borrower is going to be able to fully meet'' the higher payments that follow low introductory rates.

Cole said the Fed tried to stem faulty subprime lending at some institutions under its jurisdiction.

`Ill-Advised'

``As we saw the problems developing, we did increase our focus on efforts to review what the banking industry and mortgage originators under our responsibility were doing,'' he told Dodd. Beginning in 2003, the Fed took three formal and three informal enforcement actions to stop predatory lending and ``ill-advised'' subprime lending.

Two of the public steps related to mortgage-security accounting issues at companies in Puerto Rico. The third was a $70 million action against a Citigroup Inc. unit stemming from loans in 2000 and 2001, before the mortgage-boom began.

The OCC, which supervises 1,793 national banks, took only three public mortgage-related consumer-protection enforcement actions from 2004 to 2006, according to a review published by Bloomberg last week.

Banks Responsible

Cole stressed that ultimate responsibility lies with the banks, not the Fed. ``They are responsible for making a determination on an individual basis for the ability to repay.''

``It just seems to me you all were asleep at the switch,'' Senator Robert Menendez, a New Jersey Democrat, said during an exchange with Cole. He said Congress needs to pass legislation setting ``a national standard that clearly defines predatory lending and has consequences for it.''

While the Fed and OCC regulate the largest banks, they share some responsibilities with three other federal agencies: the Federal Deposit Insurance Corp., Office of Thrift Supervision and National Credit Union Administration. Federal regulators say their clout is limited to institutions they oversee and excludes state-chartered mortgage brokers who make subprime loans.

Dodd dismissed that argument, telling reporters after the hearing that federal law ``clearly gives the Federal Reserve Board the authority to not only regulate federally chartered institutions but state-chartered institutions as well.''

The Fed, FDIC and other U.S. regulators on March 2 directed banks to scrutinize underwriting standards, provide more information to customers about borrowing risks and ensure borrowers are able to repay loans.

Fed Action

Dodd urged Cole to look into applying the directive to state banks. The Fed official said the matter would be discussed with Fed governors after the end of a public comment period May 2.

``It's not a request, it's a demand in many ways,'' Dodd told Cole.

Sandra Thompson, director of the FDIC's division of supervision and consumer protection, told the committee there are $1.28 trillion of subprime loans outstanding. About 1 million loans are scheduled to have their interest rates reset this year and 800,000 next year, she said.

Jennie Haliburton, a 77-year-old from Philadelphia, told the committee she was sold a hybrid adjustable-rate Countrywide mortgage by a broker, which will climb in cost to $1,300 in May 2008. Her monthly Social Security income is $1,766. Samuels pledged to investigate the case.

``This will be the beginning of a real crisis that could continue to creep and creep and creep,'' Shelby said. ``We're not doing the average American any favor if we put them in a house that they're going to lose.''

To contact the reporters on this story: James Tyson in Washington at jtyson@bloomberg.netAlison Vekshin in Washington at avekshin@bloomberg.netCraig Torres in Washington at ctorres3@bloomberg.net.

Last Updated: March 22, 2007 16:45 EDT