These Fed hearings should be interesting...

In response to the firestorm of controversy over subprime loans – namely, that millions of financially unsophisticated borrowers were put into mortgages they didn’t understand and couldn’t afford – the Federal Reserve will hold a hearing on June 14th under the Home Ownership and Equity Protection Act of 1994. Here’s a link to the release.

In the release, the Fed says it wants to solicit debate on such issues as: • Prepayment penalties • Escrow accounts for taxes and insurance on subprime loans • “Stated income” or “low doc” loans • Consideration of a borrower’s ability to repay a loan

Some of the questions that the Fed wants to discuss at the hearing are intriguing, including:

• Should prepayment penalties be restricted? For example, should prepayment penalties that extend beyond the first adjustment period on an ARM be prohibited? (My opinion? No and no.)

• Should stated income or low doc loans be prohibited for certain loans, such as loans to subprime borrowers? (My view: Yes.)

• Should stated income or low doc loans be prohibited for higher-risk loans, for example, for loans with high loan-to-value ratios? (Not in my opinion.)

• Should lenders be required to underwrite all loans based on the fully-indexed rate and fully amortizing payments? (Yes! Yes! Yes!)

• Should there be a rebuttable presumption that a loan is unaffordable if the borrower’s debt-to-income ratio exceeds 50 percent (at loan origination)? (Hmmmm. That's a tough one. I see arguments both for and against.)

One other nugget I found interesting was this: The Fed notes that “some consumer advocates stated that brokers and lenders should be held to a fiduciary standard such as a duty of good faith and fair dealing or a requirement that they make only loans that are suitable for a particular borrower….Fiduciary responsibilities would, in industry’s view, create conflicts for lenders, who are responsible to their shareholders.

Interesting that the mortgage lenders come out and say this – given our obligation to our shareholders, we don’t necessarily have an obligation to put you in the cheapest, or most appropriate, loan. Our primary obligation is to maximize profits for our shareholders.

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