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Solutions to subprime woes shaping up in Congress

WASHINGTON—After the requisite finger-pointing and blame-laying, Congress and federal regulators are moving toward some fixes to problems in the subprime mortgage market, a segment that caters to borrowers with spotty credit histories and whose problems threaten the broader U.S. economy.

Congressional Democrats seem ready to bring mortgage brokers and non-bank lenders—both of whom are at the heart of the subprime meltdown—under some sort of federal regulation.

A more difficult debate continues, however, over how to make Wall Street share some of the responsibility for bad home loans that are pooled together and sold to investors as mortgage bonds.

After several months of hearings, this much is clear: Lenders are going to get explicit federal guidance about riskier home loans in response to what's now widely viewed as dangerously loosened lending standards.

"We have to put limits on what kinds of loans people make. They shouldn't be lending people a lot more money than they can pay back," said Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee.

In an interview with McClatchy Newspapers, Frank said he expects Congress to pass housing legislation "probably this calendar year" and expects it to be comprehensive.

Key Republicans and the White House are cool to the idea of new regulation legislation.

"Industry-based solutions are preferred to government intervention when addressing problems in the private marketplace," said Sen. Richard Shelby, R-Ala., the ranking Republican on the Senate Banking Committee.

White House spokesman Tony Fratto agreed: "We are going to pay attention to the ideas in Congress, but we're not inclined to support a legislative solution or look at legislative options."

But Frank believes that once housing legislation begins moving forward, Republicans will have a change of heart "because they otherwise would be vulnerable. They may not be vulnerable in the abstract, but I think they would be if they voted against it."

Subprime loans given to borrowers with little or poor credit histories represent only about 15 percent of all home mortgages. But because subprime default rates are rising fast and expected to soar late this year and next, there are concerns that they could lead to a glut of foreclosed homes just as the slumping housing sector is trying to recover. Housing problems have slowed the U.S. economy this year and could become a worse drag in the months ahead.

After a spate of congressional hearings about the subprime market, a loose blueprint of potential solutions has emerged. They include:

_Requiring escrow accounts in subprime loans: Only about a quarter of all sub-prime loans have escrow accounts that collect and pay property taxes and real estate insurance. Many subprime borrowers have been tricked into thinking they're getting lower monthly payments only to find they owe taxes and insurance on top of their mortgages.

_Restricting no-document and low-document loans: These loans were first created to help doctors and other self-employed professionals, but have become known as "liar loans" because lenders don't verify borrowers' declarations of their finances.

_Regulating mortgage brokers: Brokers originate most home loans, yet aren't held to any federal performance standard, unlike, say, stock brokers. State banking supervisors next year will debut a national database to share information about broker misdeeds and plan a uniform application form for licensing. But many in Congress want brokers under federal supervision. How and by whom aren't clear. "Somebody has to be given that authority," Frank said. Many Republicans oppose creating a new government regulator or adding to the federal bureaucracy.

_Regulating non-bank lenders: These entities have underwritten most bad subprime loans, and dozens of them are now in bankruptcy. They fall through the cracks of federal supervision. Democrats want the Federal Reserve or some other federal banking regulator to put non-bank lenders under direct supervision. Democrats also seek tighter federal regulation of bank subsidiaries that underwrite subprime mortgages.

_Liability for sellers of mortgage bonds: Most new mortgages are securitized, or pooled together and sold as mortgage bonds on the secondary mortgage market. Democrats think sellers of mortgage bonds have failed to police lenders, and thus the securitization process has given an incentive to bad lending. "Yes, it provides a lot more money, but it also meant that if you made the loan and you sold the loan, you weren't so much on the hook, and if you bought the loan, you were never on the hook," Frank said. "That's why ... there needs to be some responsibility all the way through the chain."

_Greater disclosure: Democrats and Republicans alike favor a simpler, standardized form to be presented to consumers when closing on loans. When adjustable-rate loans are involved, this form would show various potential outcomes for the borrower when interest rates go up or down.

Federal regulators are taking important steps, too:

_Major banking agencies that oversee different segments of the mortgage industry have directed lenders of all stripes to work with borrowers to avoid foreclosure.

_The Federal Reserve has taken comment and will soon publish new guidance to lenders in the subprime market that will direct them to lend only as much as a borrower can afford when an adjustable-rate loan resets to a higher rate. Low teaser rates that reset at much higher unaffordable rates are among the main reasons for the subprime problems.

_Freddie Mac, the government-sponsored home-mortgage corporation, this summer will begin buying about $20 billion worth of new mortgages that lenders make in a bid to refinance borrowers out of their troubled subprime loans. Freddie Mac packages safer loans for sale to investors as mortgage bonds.

_Fannie Mae, a similar entity, has created a Home Stay program that makes it easier for a lender to refinance a mortgage even when a borrower has credit problems. It also will allow for 40-year home loans.

_The Federal Housing Administration is boosting refinancing programs to help qualifying subprime borrowers get out of adjustable-rate loans and into fixed-rate home loans. Frank's committee has sent legislation to the full House of Representatives that would ease the FHA's 3-percent-down payment requirements, and it would lift lending caps for states such as New York and California with sky-high home prices.

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(c) 2007, McClatchy-Tribune Information Services.

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