Federal monetary regulators want to add subprime loans to the pool of mortgages with stricter regulations, but they could be moving too slowly.
Homeowners are defaulting on subprime loans at record levels and the scores of unrealized American Dreams could cripple the stumbling economy.
The desire to further scrutinize the subprime market was one of the topics of discussion at Office of Thrift Supervision's National Housing Forum this week in Washington, D.C.
The office is a division of the U.S. Treasury and Treasury Secretary Henry Paulson said the government wants to issue guidelines to banks and savings and loans that will allow people to get the home loan they need but "without taking unnecessary risks."
"Expanding opportunities for more people to buy a home is a good thing. But we do not want Americans to become overextended and see their dream end in foreclosure," Paulson said.
Subprime loans are generally more expensive than prime loans, but they are intended for borrowers who pose a greater risk to lenders, typically because of the lack of credit or previous credit problems. Without the subprime segment, some borrowers would be locked out of the American Dream.
To prevent the lockout, the number of subprime loans have grown exponentially during the last housing boom.
Federal Reserve Chairman Ben S. Bernanke, speaking in early November at the Opportunity Finance Network’s Annual Conference in Washington, D.C. said in 1994, fewer than 5 percent of mortgage originations were subprime, but by 2005 about 20 percent of new mortgage loans were subprime.
Indicating the positive impact of subprime availability he reported that from 1995 to 2004, the share of households with mortgage debt increased 17 percent, and in the lowest income group, the share of households with mortgage debt rose 53 percent.
Unfortunately, in numerous documented class action suits, state-filed cases and other claims, too many subprime loans became predatory with exorbitantly high costs, penalties and other financially abusive features often directed at specific groups, including single women, minorities, older, low-income borrowers and others who can least afford the added cost.
Other studies show members of those same groups could qualify for prime loans but are steered toward subprime mortgages instead.
"Although the emergence of risk-based pricing has increased access to credit for all households, it has also raised some concerns and questions, which are magnified in the case of lower-income borrowers. For example, although subprime lending has grown substantially, are prime credit products sufficiently available and do lenders effectively compete in all communities, including historically underserved communities?" Bernanke asked.
Perhaps not.
Much of the growing level of foreclosures is coming from the subprime market.
In the 12 months through August this year, the default rate of subprime mortgages rose to 7.74 percent from 5.53 percent in the previous 12 month period, according to Friedman Billings Ramsey Inc., analysts who follow the securitized portion of the market.
Prime loan foreclosures, on the other hand, rose only 0.24 percent, a steady average since 2000, and up only from 0.16 percent from a year earlier.
Foreclosures on subprime mortgages climbed to 3.18 percent in the month of August, up from 2.16 percent in August 2005, FRB also says. For prime loans, the foreclosure rate rose only marginally from 0.06 percent to 0.09 percent during the same month.
Another analyst, UBS Securities, says subprime loans originated this year are going bad at a 50 percent higher frequency than those issued in 2005, which suggests looser underwriting standards.
And Standard & Poor's downgraded credit ratings on a record 132 residential mortgage bond issues last quarter, mostly due to poor performance of subprime loans.
Earlier this year, the feds finalized "Interagency Guidance on Nontraditional Mortgage Products" and "Credit Risk Management Guidance For Home Equity Lending," provisions designed to curtail the rise in the risky business of so-called "nontraditional" mortgages.
There was some hope the rules for interest-only, payment-option, piggy-back, stated-income (no-doc) and other types of adjustable rate mortgages (ARMs), as well as some home equity and other home loans, would trickle down to the subprime market much of which is not federally regulated.
"It does not apply to state-regulated mortgage companies that make loans but don't take deposits. Almost 60 percent of the loans in the sub-prime market, where people of modest means and with weaker credit ratings borrow, are not subject to scrutiny by the federal regulators issuing these guidelines today," according to Michael D. Calhoun, president of the Center for Responsible Lending.
How the feds can impact the large state-regulated subprime market isn't certain but they do plan to go after the subprime market on the federal level.
"Of course, as an agency committed to the rigorous enforcement of the fair lending laws, our job is to distinguish legitimate from illegitimate sources of pricing differentials among the banking institutions we supervise. Further research to explore these questions and their possible connection to disparities in lending to members of minority groups would be highly worthwhile. In fact, the Federal Reserve’s upcoming Community Affairs Research Conference will feature several papers that explore these issues," Bernanke said during his speech.
