WASHINGTON - The Federal Reserve's proposals last week to address deception and fraud in mortgage lending will all be for naught unless the states, the Fed, and other federal agencies tighten their enforcement of the lending rules.
Lending standards weakened sharply in 2005 and 2006 as home prices soared. Fraud and predatory lending were rampant in the subprime market, which served borrowers with the weakest credit histories.
Yet there wasn't any federal sheriff. No one made sure that borrowers received complete and clear information from lenders so they would know what they were getting into - and that lenders checked to be sure borrowers would be able to handle the monthly payments. During the housing boom of the early 2000s, lenders were so anxious to write mortgages that information provided was sometimes misleading or fraudulent, and borrowers' financial backgrounds weren't verified.
At least eight federal agencies, including the Federal Reserve and even the FBI, have had some oversight responsibility for mortgage lending. Also, mortgage brokers and non-bank lenders are regulated at the state level.
"This does not change the current enforcement scheme," a senior Fed official acknowledged when explaining the rules proposed by the Fed last week. He was one of a team of officials who briefed reporters on the condition that they not be identified by name.
But the status-quo enforcement is a problem, given the weak track record on self-regulation by industry and widely varied government enforcement.
"I think, with the subprime blowup, we've seen that markets aren't good at governing themselves," said Kurt Eggert, a law professor at Chapman University in Orange, Calif.
Eggert, who is finishing a three-year term on the Fed's consumer advisory committee, credited Fed Chairman Ben S. Bernanke with recognizing the need for tighter enforcement rules. His predecessor, Alan Greenspan, did not.
"I think the Fed is now more interested in putting in consumer protections, whereas, under Greenspan, there was not that much interest in consumer protection, and there was the general feeling that markets should govern themselves," said Eggert, whose time on the advisory panel spans both chairmen.
While the proposed rules enhance consumer protection, the Fed governor who has spearheaded the revisions, Randall S. Kroszner, acknowledged that rules can achieve only so much.
"Ultimately it's really about the enforcement. It's not the rules themselves, but how they're enforced," he said, noting that many of the enforcement problems are beyond the Fed's reach.
The Fed and other banking regulators, such as the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency, enforce rules through their normal supervisory contact with banks.
But for the new Fed rules to succeed, effective enforcement will have to come from the states - and they have been widely varying in their ability and desire to do it regarding mortgage lending.
"I think we really need to see an increase in the resources that are available in states . . . to do proper enforcement," Kroszner said.
The Fed and two other federal regulators began a pilot project late this year with the Conference of State Bank Supervisors. The Fed, the Treasury's Office of Thrift Supervision, and the Federal Trade Commission will examine a sample of mortgage-lending subsidiaries of federally regulated banks and thrifts. State banking supervisors will conduct similar examinations of state-licensed subprime lenders and mortgage brokers.
The regulators will be gauging underwriting standards and whether senior management is properly managing risks as various state and federal lending laws require. These inspections could result in enforcement actions.