Primarying The Federal Reserve

Much in the way that lawmakers can get pulled from the center to the left when primaried by a member of their own party, the Federal Reserve, facing the prospect of a Consumer Financial Protection Agency that would take away some of its power, is shifting to a more consumer-friendly position on lending practices, including getting rid of the dreaded yield spread premiums that incentivize lenders to screw their customers.

The Federal Reserve on Thursday unveiled a proposal to curb abusive lending practices by reining in compensation for mortgage brokers and by helping borrowers better understand the terms of loans available to them.

The plan, which builds on a similar effort adopted by the Fed last year, comes just as the central bank is trying to fend off a legislative initiative that would strip its consumer-protection role by creating an agency to oversee consumer financial products.

"It certainly doesn't hurt the Fed that they came out with mortgage lending rules that were tougher than most of the industry was expecting," said Jaret Seiberg, a policy analyst at Washington Research Group, a unit of Concept Capital.

The toughest part of the Fed's plan deals with compensation for mortgage brokers, who act as middlemen between borrowers and lenders. These brokers can be rewarded with extra fees for placing borrowers in higher-rate loans.

The proposal attempts to end this practice by barring lenders from offering extra compensation based on the terms of the loan, including the rate. Consumer advocates have long argued that incentive-based pay contributed to the subprime mortgage meltdown.

"This plan has got the potential to eliminate one of the worst practices in the mortgage market," said Michael Calhoun, president of the Center for Responsible Lending. "The devil will be in the details. Some of the worst actors in the industry have proven to be adept at exploiting weaknesses in rules. The final rule has to be tightly and carefully written."

However these things get into law is fine with me. Whether the threat of the CFPA entices the Federal Reserve to do its job, or whether a CFPA gets enacted and does it itself, ending the practice of paying off mortgage brokers for screwing their customers is a good thing.

Of course, these are forward-looking proposals. And however solid they may be, they do not deal with the current problem of people struggling to stay in their homes and stave off foreclosures, which is only growing. The current mortgage relief efforts are simply not working. I'm glad that Sheldon Whitehouse is signaling another look at cram-down, the idea of allowing bankruptcy judges to modify loan terms with the broker. You have to give the borrower some opportunity to dictate terms, or as we have seen the bank will not modify the loans.

But there is another option, and that's own to rent. Dean Baker has pushed this proposal prominently, and it's starting to get support on Capitol Hill.

There is a simple solution that requires no taxpayer dollars, requires no new bureaucracy and can immediately help millions of people facing foreclosure. Congress can simply temporarily alter the rules on foreclosure to allow homeowners facing foreclosures the right to stay in their home for a substantial period of time (e.g. seven to 10 years) as renters paying the market rent.

The lender would take ownership of the house and would be free to resell it, but the lease would carry over for the duration of the period designated by Congress, or until the former homeowner decided to move. In this period, normal landlord-tenant laws would apply, with the exception that the lender would not have the option to evict the former homeowner without due cause.

This rule change would provide homeowners with a large degree of housing security. If they like their current home, their neighborhood, their kids' schools, they would have the option to remain there for a substantial period of time. Furthermore, by making foreclosure a less attractive option for lenders, a right to rent law should give lenders much more incentive to pursue mortgage modifications as an alternative to foreclosure.

This change should also be beneficial for neighborhoods that are plagued by large numbers of foreclosures. Keeping former homeowners in their homes will keep homes occupied, preventing the blight that often comes from vacant homes that are not maintained.

The banks will fight this, but the overall housing market will likely rise from diminishing the glut of supply. The banks would get off the hook for a lot of the upkeep of blighted properties, the cycle of foreclosures could get stopped, and they would obtain consistent revenue streams in the form of rental payments, while still holding the potential equity of selling the home. I really, really like this idea.

...of course, the Fed's nods toward consumer protection won't be enough for people like William Greider, who think it ought to be dismantled. I think it's hard to argue with Greider, considering he knows as much about the Fed as any human being alive.