Regulators take beating over defaults, foreclosures

Republican and Democratic members of the Senate Banking Committee yesterday issued a withering rebuke to federal banking regulators and executives from several large mortgage lenders for permitting a wave of defaults and foreclosures in the sub-prime home loan market.

“It just seems to me that you all were asleep at the switch. … The size of this problem — how could it be this big and you have done your job?” Sen. Robert Menendez (D-N.J.) asked a panel of banking regulators in front of a packed hearing room.
Sen. Richard Shelby (R-Ala.), the committee’s ranking member, expressed his amazement that regulators didn’t clamp down on lenders who extended credit without proper background checks.

“It defies common sense to think they’d make those payments when their incomes were not verified,” he said.

Sen. Chris Dodd (D-Conn.), the committee chairman and a 2008 presidential hopeful, called the hearing in the wake of the implosion of the sub-prime mortgage market in recent months. The House Financial Services Committee has a hearing scheduled for next week. Rep. Barney Frank (D-Mass.), the chairman of that committee, is working on a predatory-lending bill.

Lax lending standards, the explosion of risky mortgage products and rising interest rates have combined to trigger a surge in defaults on loans to borrowers with shaky credit.

At the end of last year, about 14 percent of the $1.2 trillion in outstanding sub-prime adjustable rate mortgages (ARMs) was in default, testified Sandra L. Thompson, the director of supervision and consumer protection at the Federal Deposit Insurance Corporation at the hearing. This year, 1 million sub-prime ARMs are due to have their rates reset, she added, and about 800,000 will be reset in 2008.

In his opening remarks, Dodd said that there may not be a legislative solution to deal with the millions of homeowners who face foreclosure. He said he would ask regulators, investors, lenders and other stakeholders to work together to keep defaulted borrowers in their homes.

The federal agencies charged with regulating banks and thrifts issued guidance on exotic mortgages last fall, but only announced their intention to strengthen standards in the sub-prime market in recent weeks. Dodd grilled the banking regulators over why they did not step in sooner to prevent the sub-prime meltdown.

Specifically, he wondered why the Federal Reserve did not issue a rule forcing lenders to ensure that borrowers could afford a spike in interest rates under an ARM.

“It seems to be common sense that you want to determine whether people will be able to pay at the fully indexed rate … why didn’t you do that?” Dodd asked the director of banking supervision and regulation of the Federal Reserve, Roger T. Cole.
Dodd insisted that he and Shelby were not suggesting that credit to low-income borrowers, which has ballooned since the 1980s, should be reined in.

“I don’t want anyone in this room to believe that we think sub-prime lending is the equivalent of predatory lending,” he said.