March 22 (Bloomberg) -- ``Abusive'' lending and fraud led to a surge in subprime mortgage defaults, a top U.S. bank regulator told senators investigating the subprime mortgage market.

The U.S. Office of the Comptroller of the Currency is working to correct lending standards that have slipped, Emory Rushton the agency's senior deputy comptroller, told the Senate Banking Committee in Washington today.

``It is clear that some subprime lenders have engaged in abusive practices, and we share the committee's strong concerns about them,'' Rushton said in prepared testimony. ``We are now confronting adverse conditions in the subprime mortgage market, including disturbing but not unpredictable increases in the rates of mortgage delinquencies and foreclosures.''

The OCC and Federal Reserve are among regulators chastised by Congress for enforcement lapses as delinquencies climb and threaten to worsen a housing recession that's weakening the economy. The deteriorating subprime mortgage market -- loans to people with poor or limited credit histories -- has pushed some lenders out of business and forced firms such as Countrywide Financial Corp. to tighten standards.

`Spectators' Too Long

``Our nation's financial regulators were supposed to be the cops on the beat, protecting hard-working Americans from unscrupulous financial actors,'' Senate Banking Committee Chairman Christopher Dodd said at today's hearing. ``Yet they were spectators for far too long.''

Some economists also speculated that the meltdown in subprime mortgages helped persuade the Fed to drop its tilt toward higher interest rates. For the first time since the Fed ended a two-year run of rate increases in August, the central bank yesterday signaled that its next move might be either to lower or raise borrowing costs, instead of just the latter.

More than two dozen mortgage companies have shut, cut or sold operations since the start of 2006, and rising defaults have prompted calls in Congress for legislation. Dodd, a Connecticut Democrat, wants to know why regulators didn't take more aggressive action sooner. Dodd is seeking the Democratic presidential nomination.

Fed's Data

Data collected by the Federal Reserve Board clearly indicated lenders had started easing standards by early 2004, Dodd said. The Fed continued to encourage the development and use of risky adjustable-rate mortgages that are now ``going into foreclosure at record rates,'' he said.

Late payments on subprime loans reached a four-year high of 13.3 percent in the fourth quarter, while foreclosures on all home loans also reached record levels, the Washington-based Mortgage Bankers Association reported last week.

There are $1.28 trillion of subprime loans outstanding, said Sandra Thompson, director of supervision and consumer protection at the Federal Deposit Insurance Corp.

About 1 million loans are scheduled to have their interest rates reset this year and 800,000 next year, she said, and delinquencies are likely to continue rising.

Regulators testified that they did take some enforcement actions, while putting the onus on lenders to police themselves as they made loans whose costs climbed after low introductory rates.

Roger Cole, the Fed's chief bank supervisor, conceded that ``given what we know now, yes, we could have done more sooner.''

The OCC's Rushton warned against a heavy-handed response to the borrowing binge between 2004 and 2006 that's now turned to bust. There were a variety of factors making the subprime market problems worse, he said, including ``fraud in the application process, intense competition and a relaxation of lending standards.''

States' Role

Rushton defended the OCC, saying there's little evidence that national banks or their subsidiaries engaged in predatory lending. National banks and their subsidiaries accounted for less than 10 percent of the $600 billion in subprime mortgages issued in 2006, he said.

State-regulated lenders that aren't banks, and brokers have captured the largest share of the subprime market. Hedge funds and private-equity investors bought their loans and securities backed by these loans, Rushton added.

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.

Consumer advocates say federally regulated banks and brokerage firms both fund and work with state-regulated lenders in many cases, giving them a stake in what's happening at a more local level.

In the next two to three years the monthly payments on an estimated $2.3 trillion of adjustable first mortgages will begin to reset higher and may push about 1.l million loans amounting to $326 billion into foreclosure, according a study by mortgage risk data provider First American CoreLogic.

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net.

Last Updated: March 22, 2007 14:47 EDT