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Congress's Cushions For Sub-Prime Fallout

September 5, 2007 - by Donny Shaw

While we all wait to see if the Fed will unleash an interest rate cut to help ease the struggling financial markets, Congress is taking their own action to jump-start things where the problems began: in the housing market. Here’s a look at some of the ideas they have been kicking around.

Revamping the Federal Housing Administration

President Bush recently threw his support behind a Democratic proposal, HR.1852, to make some changes the the FHA that would help millions to become and remain homeowners. “It would be a good task for Congress to come and get FHA modernization done so that we can help these people refinance their homes, so more people can stay in their homes. I look forward to signing a bill as quickly as possible,” Bush said.

The FHA helps people afford homes by insuring loans that get issued by federally qualified lenders. By insuring the loans, lenders are able to pass better rates along to potential homebuyers. The bill, which is expected to be debated and approved by the House of Representatives soon, would make several adjustments to the FHA. First, it would increase the size of loans that the FHA can insure. By increasing the limits of FHA loans, more people in high-cost areas who don’t qualify for fixed-rate loans will turn to FHA loans instead of sub-prime loans. Secondly, the bill would eliminate a three percent down payment requirement on FHA loans for first-time homebuyers. Sub-prime loans are offered without a down-payment requirement, so people who can’t afford to pay some up front have been unable to opt for the more-affordable FHA loans. Finally, the bill would reduce brokerage requirements so that more lenders would be eligible to offer FHA loans to prospective lenders.

Revamping Fannie and Freddie

Fannie Mae and Freddie Mac (loose acronym-portamanteaus of “The Federal National Mortgage Association” and “Federal Home Loan Mortgage Corporation” respectively) are government-sponsored enterprises (GSEs) that, together, own or guarantee repayment of about 40 percent of the country’s residential mortgages. They aren’t government-backed or protected, but they were created during the New Deal to help replenish the mortgage market and keep it liquid. Their basic function is to bundle together loans on the secondary market and sell them to investors on the open market as less-risky mortgage-backed securities. A bill that has been approved by the House would allow the GSEs to play a bigger role.

The bill, H.R.1427, would lift their portfolio caps, which are currently set at $727 billion (Fannie) and $724 billion (Freddie). It would also allow them to deal in bigger loans. Currently GSEs are only allowed to buy up smaller, conforming loans, which are more in line with median house prices. If they were allowed to deal in larger loans as well, they could spread the liquidity that they offer to higher parts of the market.

Industry interests such as The National Association of Realtors, the Mortgage Bankers Association, and the National Association of Home Builders have been lobbying Congress and the Administration for this bill. President Bush hasn’t officially stated that he would veto it if the Senate passed it as well, but as one lobbyist told CongressDaily ($), “It seems to me right now you are not going to get a GSE bill the president will sign out of [Senate Banking Chairman] Dodd or [House Financial Services Chairman] Frank.”

Eliminating the “Phantom Income” Tax

Rep. Robert Andrwes (D-NJ) has introduced a bipartisan bill, H.R.1876, that would eliminate a tax on debt that is forgiven by a bank who gave a sub-prime mortgage to a homeowner who was forced to foreclose. This simple proposal could boost liquidity in the housing market by keeping more money in the pockets of potential homebuyers who are trying to recover from a sub-prime loan to get back on their feet and buy another home. Bob Hunt of Realty Times describes a situation where the bill would benefit the homeowner:

>Bob and Carol purchased their home in 2005 for $400,000. They obtained 100 percent, interest-only, financing, and the balance is still $400,000. Now, the interest-only phase is over, and the loan has been recast at a higher interest rate with both principal and interest payments due. They can’t afford the payments, and must sell. But now the property is only worth $380,000. They receive an offer for $380,000. The lender agrees to accept that amount, and takes a $20,000 loss.

Now, some mortgage lenders have been willing to forgive the difference between the original loan and what the homeowner is able to pay back after a short sale — as described above — or a foreclosure. That difference is treated as debt relief, which is taxed. So, on top of loosing their house, Bob and Carol in the above example would owe 35 percent on what was forgiven them by the lender.

Preventing Future Predators

Finally, a plan to prevent predatory lending practices from occurring in the future. House Financial Services chairman Barney Frank (D-MA) is planning on introducing a bill later this month that would protect consumers by increasing regulations of the mortgage industry. The Hill’s got the scoop:

>Frank’s legislation will tighten underwriting standards and include language designed to prod states to enact minimum standards for mortgage originators involving disclosure and broker licensing, according to discussions that Financial Services Committee staffers had with lobbyists over the recess.
>In an interview, Frank suggested that he wanted to bring the standards applied to non-bank mortgage lenders and brokers more in line with those adhered to by the banking industry. “We have a regulated and an unregulated sector in terms of mortgage loans, and the regulated sector has worked much better,” he said.
>The legislation is also likely to allow victims of lending abuses to sue the Wall Street banks that purchased their mortgages and resold them to investors — thereby forcing Wall Street to stand guard against predatory loans.
>Yet Frank is expected to stop short of imposing full “assignee liability” to these financial firms. Instead, these firms may shield themselves from liability if they adhere to certain precautions and standards. “The degree of liability you place on the secondary market isn’t as much as on the originators,” Frank said.

Keep up with these bills by subscribing to their rss feeds. Click on the orange icon in the right of their pages’ address bar and you’ll be automatically kept up to date with their status in Congress. You can also monitor news and blog coverage of them by clicking the “more articles…” links at the bottom of the bill pages and subscribing to the feeds in the address bars there.

UPDATE: And here’s one from Chris Dodd (D-CT):

>Senate Banking Chairman Dodd introduced legislation today designed to curb lending abuses that have roiled the subprime mortgage market. The bill would place requirements on mortgage brokers by clarifying their fiduciary duty to borrowers. The measure also would expand the protection for those who assume a high-cost loan under the 1994 Home Ownership and Equity Protection Act. Dodd argues that many brokers and lenders have avoided HOEPA triggers that have allowed them to continue to offer questionable products to borrowers. Under his bill, HOEPA loans would include a practice known as yield spread premium in determining whether the mortgage is a high-cost loan. Under a yield spread premium, mortgage brokers are eligible to receive fees from lenders for issuing a loan with a higher interest rate than the minimum rate for which the borrower could have qualified. It also prohibits all balloon payments and prepayment penalties for high-cost loans. The mortgage broker industry has defended the practice saying it gives the borrowers more options.

>The bill would prohibit a loan originator from steering a borrower to a costlier loan. For example, if a borrower qualifies for a prime loan, a broker or lender could not give them a subprime loan. Loans that do not qualify for HOEPA but are not considered prime would receive new protections that include no prepayment penalties, yield spread premiums and mandatory requirement of documentation of the borrower’s income. It also would prohibit pressure from loan originators on appraisers to hit a certain target on a house price. Some consumer activists lauded the legislation. “The centerpiece of Sen. Dodd’s bill will establish in federal law the principle that all lenders have an obligation of good faith and fair dealing when making a home loan. This approach will help restore a long-awaited measure of fairness to the mortgage market,” said Margot Saunders of the National Consumer Law Center.

I’ll put up a link to Dodd’s bill once we get it on OpenCongress — probably tomorrow.

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