April 10 (Bloomberg) -- The top Democrat and Republican on the House Financial Services Committee said investors in mortgage bonds should be liable for deceptive loans made by banks.

Democratic Chairman Barney Frank of Massachusetts and Spencer Bachus of Alabama, the committee's highest-ranking Republican, said such legislation would discourage lenders from extending loans to people with poor credit histories by making it more difficult and expensive for the banks to sell the mortgages.

``More money was being lent than should have been lent,'' Frank said in an interview from Washington. Frank, who last month predicted that the House would approve such a bill this year, said growth in the market for mortgage bonds ``provided liquidity without responsibility.''

An agreement by the two lawmakers may increase the likelihood legislation will be passed this year. The cost of borrowing would rise and curb financing for some lenders and subprime homebuyers, said David Brownlee, who oversees $14 billion as head of fixed income at Sentinel Asset Management in Montpelier, Vermont. It would also reduce opportunities for the Wall Street firms that pool the home loans as securities.

A total of $2.12 trillion of mortgage-backed bonds were sold last year, according to the Securities Industry and Financial Markets Association, a New York-based trade group. About $540 billion of the bonds are backed by subprime mortgages, or loans to people with poor credit, up threefold since 2001, data compiled by New York-based Bear Stearns Cos. show.

``There has been no specific agreement'' between Frank and Bachus on ``the inclusion of any provision in subprime lending reform legislation,'' Bachus said in an e-mail statement today.

Rising Delinquencies

In the fourth quarter, 13.3 percent of subprime borrowers made late payments, the highest delinquency rate in four years, according to the Mortgage Bankers Association in Washington.

Since the beginning of 2006, at least 40 subprime lenders have halted operations, filed for bankruptcy or sought buyers amid rising borrower defaults. Irvine, California-based New Century Financial Corp. filed for Chapter 11 protection last week as delinquencies, limited access to capital and government investigations brought its business to a halt. The company was the second-largest subprime lender in the U.S. last year after London's HSBC Holdings Plc.

``There is no doubt that securitization has had an impact on looser underwriting standards we have seen by lenders,'' Federal Deposit Insurance Corp. Chairman Sheila Bair told the House Financial Services subcommittee on March 27.

Investors in bonds backed by subprime mortgages currently face sufficient liability, Brownlee said. The investment banks underwriting the bonds ``aren't idiots, they're already laying off the risk of subprime loans on investors.''

Sales Fall

Mortgage lenders seek to minimize their risk and raise new capital by selling the loans they make to Wall Street firms, which bundle them into securities for sale to investors.

Sales of bonds backed mainly by subprime loans are already down, falling 37 percent to $79.3 billion this year through March 29 from $125 billion in the same period a year earlier, according to Citigroup Inc.

The extra yield investors demand to buy floating-rate BBB rated bonds backed by subprime mortgages rose to a record on 5.5 percentage points over the one-month London interbank offered rate last week, from about 1.5 percentage points in early February, according to RBS Greenwich Capital.

Bachus said he favors legislation similar to a law enacted in New Jersey in 2003 enabling homeowners whose loans are the result of predatory lending to gain compensation from lenders and investors who purchased the mortgages. The indemnity includes attorneys' fees, the borrower's total loan payments and the cost of terminating the borrower's remaining liability.

New Jersey's Safeguards

The New Jersey law erected safeguards against predatory lending, including a requirement that lenders certify that borrowers can repay the loan. The borrower must receive financial counseling when financing mortgage points and fees, which may not exceed 2 percent of the total loan amount.

The ``assignee liability'' spelled out by ``New Jersey is what I would go for, it works,'' Bachus said in the interview.

The New Jersey law, which ``could be the starting point for national legislation,'' allows ``purchasers of securitized loans to protect themselves from liability via due diligence,'' Bachus said in the e-mail statement.

Frank declined to describe what he would include in any bill.

Lenders this decade have increasingly relied on mortgage- backed securities to fund new loans rather than tap capital from federally insured bank deposits. Frank called the process flawed, saying that as a subprime financing mechanism, banks' exposure to the risk of default is excessively diluted.

By dispersing risk, the bonds fueled reckless and unscrupulous lending and compromised underwriting standards, he said. ``There should be a decrease'' in the money available for subprime mortgages, he said.

Blemished Credit

Subprime mortgages are made to people with blemished credit records or heavy debt loads, and typically charge 2 to 3 percentage points more than rates to people with less-risky credit profiles. The loans often carry adjustable interest rates that can cause payments to jump in later years.

Bachus said there is a danger lawmakers could overreact and cut off financing for too many subprime borrowers.

``It's very important to preserve the liquidity in the subprime lending market,'' he said. ``If you get too aggressive with assignee liability, you dry up the ability of low and middle income families to own homes.''

Reckless investors shouldn't receive any sympathy, Frank said.

``Our job is to continue to have money available for people to continue to buy homes with minimal chance of these kind of disasters,'' Frank said. ``The effect this has on the ability of people in the bond market to make money is simply not a factor.''

To contact the reporter on this story: James Tyson in Washington at jtyson@bloomberg.net

Last Updated: April 10, 2007 18:21 EDT