Federal Reserve to Propose New Curbs to Target Subprime Mortgages. Further Analysis and Discussion with David Wyss of S&P

Federal Reserve staff recommended that policy makers issue new restrictions on subprime mortgages, from a ban on low documentation loans to limiting penalties for borrowers who prepay their debts.

The new proposal, which the Board of Governors will vote on later today, follows months of public comment by Congress and consumer advocates, who urged the Federal Reserve to toughen consumer protections.

Finance industry officials warned that a crackdown would curtail lending in the midst of the housing recession. “Mortgage-market discipline has in some cases broken down and the incentives to follow prudent lending procedures have, at times, eroded”, Fed Chairman Ben Bernanke said in a statement.

The proposed new rules “were carefully crafted” to deter “improper lending” without “unduly restricting mortgage credit availability”, he said.

The proposed changes are the product of Central Bankings biggest regulatory initiative since Bernanke took office in February 2006.

The Fed chief is aiming to preserve the Fed’s consumer protection role after Democratic lawmakers blamed it for lax oversight and introduced legislation to set rules for mortgage lenders. The Fed proposed tightening restrictions on so called pre-payment penalties, requiring the escrow of taxes and insurance, and banning loans made without verification of income or assets.

Lenders would be responsible for determining whether their customers can afford a loan after the initial interest rate resets.

Federal Reserve To Revise Home Ownership and Equity Protection Act

The Federal Reserve Board will meet Dec. 18 to issue long-awaited revisions to its Home Ownership and Equity Protection Act regulations that address abuses associated with the subprime mortgage industry.

The proposed HOEPA rule will address prepayment penalties, failure to escrow taxes and insurance, stated income and low documentation lending, and ability to-repay standards.

In a letter to the Fed, 17 Democrats on the Senate Banking Committee urged the Fed to act “forcefully” to protect consumers.

“We appreciate the fact that the Board is moving forward with a rule making under HOEPA, and expect the Board to meet the duty Congress entrusted to it to end the abusive practices … that have undermined confidence in the subprime mortgage market and the economy as a whole,” the Dec. 7 letter says.

Federal Reserve Considers Subprime Mortgage Escrow Mandate

The Federal Reserve Board is close to proposing that all subprime mortgages should have escrow accounts, according to a Fed governor who is working on updating the Home Ownership and Equity Protection Act regulations.

The failure to escrow taxes and insurance can lead to payment shock, Randall Kroszner told a Consumer Bankers Association fair-lending conference. “It is common practice for these payments to be escrowed in prime markets, and I see no reason that escrows should not be standard practice in the subprime markets, too,” Mr. Kroszner said.

The Fed is expected to issue proposed changes to the HOEPA regulations before the end of the year. Mr. Kroszner said the Fed also plans to issue proposals by the year-end that ban several deceptive advertising practices and require important consumer disclosures earlier in the mortgage process so consumer can shop around and compare loan products.