Hahn and Passell Discuss Fed’s Plan to Rid Mortgage Market of Ill-Advised Loans

February 26, 2008

In a paper released by the Reg-Markets Center in Washington DC, Criterion affiliate Robert Hahn and Milken Institute senior fellow Peter Passell analyze the Fed’s plan to minimize the damage of the late housing boom, in which untold numbers of Americans with marginal credit were sold mortgages with terms that they didn’t understand. They argue that the Fed’s plan, all parts considered, looks reasonable.

In their paper, Hahn and Passell discuss the parts of the Fed’s plan (which is still open to public comment and modification) that seem reasonable. For example, the new rules would require mortgage brokers to disclose whether their fees are linked to the interest rates that they charge. In the same spirit, the Fed would bar lenders from advertising teaser rates in foreign languages to immigrant communities while making legal disclosures in English.

They also discuss other pieces of the Fed’s plan that they find problematic. Among the important legal changes, lenders would be obliged to base origination decisions on the ability of borrowers to make monthly payments (rather than the value of their collateral), to create escrow accounts for owners’ tax and insurance payments, and to end prepayment penalties before adjustable-rate mortgages reset for the first time.

Hahn and Passell conclude that although the Fed might be giving too little consideration to the potential collateral damage in attempting to rid the mortgage market of ill-advised loans, it would be foolish to make the best the enemy of the good. At the very least, the Fed’s proposed rules are likely to head off far more costly legislation, especially if foreclosure rates head for the stratosphere in coming months.

To view the Hahn-Passell paper on subprime mortgages, click here.