Dec. 19 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke took steps to restore the central bank's reputation after lawmakers blamed it for failing to contain the subprime mortgage crisis, announcing rules to rein in abusive lending.

Fed governors unanimously proposed banning subprime mortgages that lack income documentation and eliminating most prepayment penalties. The plans, announced yesterday after a six-month review, also make lenders responsible for determining whether borrowers can afford their mortgages even after low starter rates expire.

``Against a background of doing nothing, this is a step in the right direction,'' said Democratic Representative Brad Miller of North Carolina, who had urged stronger regulation. The Fed ``has had rule-making authority since 1994, and this is the first time they've proposed rules, so I'm not inclined to come down on Mr. Bernanke like a ton of bricks,'' he said.

The Fed's efforts to restrict some lending practices while steering away from a complete ban on some products drew a mixed reaction from lawmakers and consumer advocates, who both praised and criticized the Fed.

The plans, the Fed's biggest regulatory initiative since Bernanke, 54, took office in February 2006, are open to public comment for three months before officials finalize the rules.

Democratic committee leaders in Congress pledged to keep pushing legislation.

`Serious Questions'

``It raises serious questions as to whether the Federal Reserve is the appropriate institution to house consumer- protection functions,'' Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said in a statement.

Representative Barney Frank of Massachusetts, who heads the House Financial Services Committee, judged the plan ``too weak to restore confidence in the mortgage market,'' Steve Adamske, Frank's spokesman, said in an e-mailed response to questions.

``Congress must act immediately to pass legislation,'' said Senator Charles Schumer of New York, who will speak at 10 a.m. today in Washington on proposals to prevent foreclosures.

Finance-industry lobbyists warned that a crackdown on subprime mortgages would curtail lending in the midst of the housing recession.

``There is much to commend and much to worry about in the proposed rules,'' said Edward Yingling, head of the American Bankers Association in Washington. ``We worry that some of the product restrictions could make it harder for bankers to tailor products for their customers.''

`Got It Right'

``The best changes are the ones that everybody hates because that means you just about got it right,'' said Christopher Low, chief economist at FTN Financial in New York. ``The Fed got it as right as they are going to get it. You need a certain amount of flexibility.''

The package covers all high-cost mortgages, defined as loans with rates at least 3 percentage points above a comparable Treasury security for first mortgages and 5 percentage points for second loans, or home-equity loans.

Subprime mortgages are usually made to people with poor or incomplete credit histories. Subprime delinquency rates reached 16.3 percent in the third quarter, from 14.8 percent the previous three months.

The Fed also voted to require the escrow of taxes and insurance, including the costs in monthly statements to prevent what Governor Randall Kroszner called ``payment shock.''

`Broken Down'

``Mortgage-market discipline has in some cases broken down and the incentives to follow prudent lending procedures have, at times, eroded,'' Bernanke said at the meeting. The proposed rules are designed to deter ``improper lending'' without ``unduly restricting mortgage credit availability,'' he said.

The proposal also outlined new disclosure rules aimed at mortgage brokers, appraisers and solicitors. The rules apply to both prime and subprime loans.

Fed governors approved prohibiting lenders from paying brokers fees in excess of what the borrower initially agreed. The proposal bars coercion of appraisers, and defines seven advertising practices as misleading or deceptive.

``It doesn't do a lot of harm and it potentially can do some good,'' said Brenda Muniz, Washington-based legislative director for Acorn, a consumer advocacy group. ``There are a lot of unanswered questions'' about how the rules will be enforced she added. ``Is it enough? No. Is it too late? Yes. That is where we are. It's hard to be wowed in this town.''

Legislative Efforts

House lawmakers last month passed legislation sponsored by Frank that would require lenders to ensure that borrowers are issued loans they can afford to repay. It would also strengthen oversight of mortgage brokers. Dodd introduced a similar bill in the Senate last week.

Congress also gave final approval to legislation to expand the ability of the Federal Housing Administration to insure mortgages for more subprime borrowers, sending it to President George W. Bush for his signature. The Bush administration separately this month negotiated a freeze of up to five years on some subprime mortgage rates.

Housing figures yesterday indicated the industry's slump will extend into next year. Permits for building new homes slumped to the lowest in 14 years last month, the Commerce Department said.

``We always lock the barn door after the horse has gone,'' said David Wyss, chief economist at Standard & Poor's in New York. Fed officials are hoping to ``restore confidence'' so lenders ``will start making these loans again,'' he said.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: December 19, 2007 00:12 EST