New policies, not regulations, will set lenders straight

Published 7:19 pm Friday, July 31, 2009

The late congressman Morris Udall was once an unsuccessful Democratic candidate for president. The early stages of his campaign for the nomination seemed to be going well, but a veteran reporter’s observation about his chances brought him up short. “You’re too funny to be president,” said columnist James J. Kilpatrick.

Udall did have a wonderful sense of humor, and it was the kind that managed to bring smiles and laughter without the bitter taste that sarcasm and irony can sometimes leave.

Still, the columnist was right. A sense of humor is a characteristic that sooner or later breeds distrust in Washington, D.C. Politicians and bureaucrats instinctively know that humor is the natural enemy of self-importance. And where would they be without self-importance?

It is not surprising, then, that the Federal Reserve might not see the humor, or at least the irony, in the fact that its proposal to make mortgage and home-equity loan rules simpler and easier to understand … is 660 pages long.

To be sure, it’s not the Fed’s fault that the proposed rule changes are enough to bring your high-speed Internet connection to its knees. What has to be done in order to simplify things involves changes in Regulation Z, which involves changes to the Truth in Lending Act. As always in Congress, simplifying things is more difficult than just adding another layer of complexity.

The heart of the proposal is an effort to make sure that borrowers understand what they are getting themselves into. It starts when people apply for either a mortgage loan or a home-equity line of credit. Applicants would be given a “one-page list of key questions” that they should ask about the loan — things like what the actual annual percentage rate is when you add in the fees and closing costs; and what their rate looks like when compared with the rates for people with top credit ratings.

Applicants for adjustable-rate mortgage loans would be given information on how their monthly payments could change, and what negative amortization really means to the homeowner. The proposed change would also lengthen the notification time for changes in monthly payments. It is now 25 days and that would be extended to a minimum of 60 days.

The Fed is also trying to reduce the confusing, last-minute shuffling of documents at home loan closings. The new regulations require that mortgage borrowers be provided with the final disclosure documents at least three days before the loan closing.

Home equity loans receive a lot of attention in the new proposal, as new Fed rules attempt to reshape these contracts to make their terms more visible and the entire package more consumer-friendly. For starters, the new rules prohibit lenders from terminating a loan unless the borrower is at least 30 days late in making a payment.

There are a total of 32 new or revised forms included in the proposal; 18 for home equity loans and 14 for mortgage loans. Each of these discloses some aspect of the loan — rates, rate changes, risks, etc. — and all are designed to be clear and direct.

There are limits to how clear and direct these forms can be, though. By the time words swim upstream past the lawyer-speak dam, the banker-speak dam, and the government-speak dam, they are pretty much exhausted and not good for anything.

The real problem with the proposal isn’t the forms, though. People with neither income nor savings who believe that someone will lend them $350,000 to buy a house are not sufficiently in touch with the real world to pay attention to disclosure forms. There is no way that they will read them carefully or care about their contents.

In the zero-down, sub-prime market — the source of most of the mortgage problems — the highest and best use of these forms would be take all 32 of them, roll them up and whack the lending officer upside the head with them. The focal point of our regulatory effort should be eliminating the problem, not documenting it.

If lenders want to risk their own money by lending to high-risk borrowers, let ‘em. This is not an economic policy issue. If they wish to jeopardize their fiduciary responsibility by lending other people’s money to high-risk borrowers, that is a regulatory matter. It still isn’t an economic policy issue, really.

But if they wish to package up that high-risk loan and sell it in our financial markets, it is an economic policy issue. They should either be stopped or made to include a tobaccolike, toxic asset warning on every document and every electronic sale. “Warning. This product may cause serious damage to your financial health.” That’s not funny, but we can live with that.

James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.