Forget Congress. Real Reform Lies With The Federal Reserve

Give the Federal Reserve some credit. Not only is it (for now) propping up a broken mortgage finance system with a trillion-dollar-plus commitment to buy mortgage-backed securities from Fannie Mae, Freddie Mac, and Ginnie Mae, the Fed is also combing through its regulations to fix glaring vulnerabilities, so the current crisis doesn't repeat itself.

While campaign contributions from the financial industry are shredding financial reform legislation in Congress, the real action is taking place at the Fed.

But not if the National Association of Mortgage Brokers can help it. Just before Christmas, the group rallied thousands of its members to protest new rules the Fed is currently considering that would effectively destroy brokers' compensation lifeline -- the yield spread premium.

Yield spread premiums are payments that brokers receive when they sell a borrower a higher-interest loan than he or she actually qualifies for. Brokers defend yield spread premiums as a way for consumers to pay off their closing costs over time. In proposing its restrictions, the Fed came to a very different conclusion: YSPs pose "significant risk of economic injury to consumers," because they give brokers a powerful incentive to put borrowers into loans that are too expensive and risky.

Or as official TARP watchdog Elizabeth Warren puts it, a YSP is "a bribe to steer you to the loan that is more expensive for you and more profitable for the lender."The main purpose of the proposed Fed rules is to make sure borrowers taking out mortgages better understand what they're getting into. Dovetailing with HUD's recent upgrade of its Good Faith Estimate, the Fed is proposing clear new disclosures that would tell consumers exactly what their mortgages will cost and what kind of risks they contain, including negative amortization (loan balances that grow instead of shrink), balloon payments and adjustable rates. Borrowers would also find out how their offered annual percentage rate (APR) compares with those offered to consumers with excellent credit. If the Fed has its way, consumers will also get a one-page list of questions to ask about the mortgage they're being offered.

The mortgage brokers can live with that. What they're determined to stop is the assault on YSPs. NAMB's Christmas Eve gift to consumers was a 41-page attack on the proposed new rules, which would prohibit any compensation to mortgage lenders or brokers based on the terms or conditions of the loans. That would effectively kill yield spread premiums, and with it the biggest force that pushed millions of borrowers into subprime loans who actually qualified for prime mortgages.

The Fed got nearly 2,600 comments, most of them from mortgage brokers passionately defending yield spread premiums. And no wonder they're upset: lenders, brokers and bankers had gotten mighty used to the Fed doing things their way. For years Congress asked the Fed to lay out these kinds of rules to protect consumers, and Fed chief Alan Greenspan deliberately ignored the request. That's why subprime lending raged with so little regulation.

Now the lenders' friend has turned on them. While key members of Congress have been bought off by financial industry campaign contributions and lobbying, the Fed isn't going to be swayed by cash bribes. It's plowing ahead now as the leader on reform. Next up is a rule that will make sure that all borrowers get a notification when their mortgage has been sold into a mortgage-backed security, and at least a contact number to call. Want to weigh in? Here's the place to do it.
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