On Friday, Sept. 29, the interagency group representing the Federal Reserve, Federal Deposit Insurance Corp., Office of the Comptroller of the Currency, Office of Thrift Supervision and the National Credit Union Administration issued its “final guidance” on nontraditional mortgage products (henceforth “Guidance”). It is essentially a theological document.
Guidance is designed to shield the agencies from the wrath of God (Congress) if the flood should come by demonstrating that the agencies did all in their power to stop the sinful behavior that brought it on. It is theological also in that most of it is given over to preaching the gospel. Here are a few representative samples out of many dozens:
- “Management should ensure that loan terms and underwriting standards are consistent with prudent lending practices, including consideration of a borrower’s repayment capacity.” (p.17)
- “Loan terms should be based on a disciplined analysis of potential exposures and compensating factors to ensure risk levels remain manageable.” (p. 19)
- “When promoting or describing nontraditional mortgage products, institutions should provide consumers with information that is designed to help them make informed decisions when selecting and using these products.” (p.33)
I have italicized the word “should” because it is so prevalent in theological writings. In the 22 pages that constitute the core of Guidance, excluding appendices and a long introduction on comments made on an earlier draft, the word appears 102 times.
Yet most of those who preach against sin also declare that they were the worst sinners of all, before they repented. This central feature of most sermons is nowhere to be found in Guidance. So I decided to repair this omission by writing their repentance statement for them:
“On the issue of risk underwriting and management, we regret that, because of our slowness to react, we did nothing to prevent an onslaught of foreclosures in the next few years. By the time we issued this document, most of the damage had already been done. The time for action was during the euphoric years of rising home prices, because this was the major stimulus for the widespread use of option ARMs (adjustable-rate mortgages), interest-only mortgages, 100 percent loans, and stated-income loans.
Regretfully, we were asleep at the switch. Now that prices have crested, in many areas subsiding, lenders are tightening their underwriting requirements for that reason, not because of anything we have done.
As penance, we are setting up a permanent interagency group, with permanent research staff, the mission of which will be to develop early warnings of market excesses that could threaten the stability of the financial system.”
“On the issue of consumer protection, we recognize that the disclosure rules mandated by Government are the first line of defense, and that these have been a shambles; perhaps worse than nothing. We regret that we have done so little to fix it.
In the aggregate, disclosures are excessive, overwhelming borrowers who can’t sort the important disclosures from the garbage. ARM disclosure in particular is in shambles. On an option ARM, which has been a focal point of our guidance, the rules require disclosure of the interest rate in month one, but the index and margin, which determine the rate in months 2-359, need not be disclosed.
Preaching to lenders that they should voluntarily provide better disclosure is hypocrisy. No sane lender will disclose negative information that can cause a borrower to go to another lender, unless the other lender does the same. That is why disclosure must be mandatory.
As penance, we plan to propose to Congress that the existing system be replaced by one in which lenders become responsible for providing adequate disclosures for each instrument. A new private/public entity would be created to develop the general disclosure principles that lenders would be required to meet, and determine the acceptability of the disclosures submitted to it.”
There are a few concrete rules stipulated in Guidance, to go along with all the preaching, but discussion of these will have to wait for another occasion.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
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