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Fed governor warns about nontraditional real estate loans

Says banks must carefully manage risks

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The Federal Reserve Bank is concerned that U.S. banks' current risk-management techniques may not be sufficient for the level of risk in nontraditional mortgages such as interest-only mortgages, a governor of the board said last week. Speaking at the Financial Services Institute in Washington, D.C., Feb. 2, Governor Susan Schmidt Bies addressed the challenges of risk management, specifically targeting interest-only (IO) and "payment-option" adjustable-rate mortgages in which a borrower has flexible payment options (option ARMs). "An institution's risk-management processes should allow it to adequately identify, measure, monitor and control the risk associated with these products," Schmidt said, citing draft guidance issued by the Fed along with other banking agencies governing such products. Schmidt said that assessing borrowers' ability to repay such loans, including monthly payments when amortization begins and interest rates rise, is of key importance. The governor noted that ther...