US eyes ban on mortgage ‘liar loans’

US eyes ban on mortgage ‘liar loans’

By Tom Braithwaite in Washington

Published: May 12 2010 22:37 | Last updated: May 12 2010 22:37

The US Senate on Wednesday approved an amendment to ban “liar loans”, mortgages that allowed borrowers to overstate their incomes, as debate on the financial regulation bill targeted one of the causes of the crisis.

The amendment to require income documentation proposed by Jeff Merkley, a Democratic senator from Oregon, and Amy Klobuchar, a Democratic senator from Minnesota, was passed with some Republican support in a rare example of bipartisan agreement on housing policy.

“This outlaws no-documentation liar loans on income,” Mr Merkley told the Financial Times, adding that bonuses for originators who steered borrowers to expensive loans – “one of the worst parts of the mortgage retail” business – would also be banned by the rule change.

Lenders would be obliged to hold 5 per cent of any mortgage they wrote as part of the changes. “No one had any skin in the game,” said Ms Klobuchar during the debate on the change. “These lenders never intended to keep the loan long enough for that to matter.”

The widespread practice of selling mortgages to borrowers who had little hope of repaying the loans, coupled with the explosion in securitisation, helped to spread bad loans across the financial system in what is recognised as a key cause of the crisis.

But in drawing up rules to prevent a repeat of the 2008 crisis, Congress has focused less on the causes in the housing market and more on limiting the activities of financial companies and working out how to wind them up safely if they get close to collapse.

The parties are sharply divided on how the housing market should look, with Republicans criticising Democrats for skirting the issue of how to deal with Fannie Mae and Freddie Mac, the loss-making quasi-government entities that guarantee mortgages.

A Republican amendment to change underwriting standards failed. “It no longer is the American dream that someone owns a home – it’s the American entitlement,” said Bob Corker, the Republican from Tennessee, after Democrats voted down his bid to impose a minimum 5 per cent downpayment on mortgage borrowers.

The National Association of Realtors opposed the change on the grounds that it would choke off a housing market recovery.

“As our nation continues to recover from the worst economic downturn since the Great Depression, realtors are cognisant that lax underwriting standards brought us to this point, and must be curtailed,” the trade association wrote to senators. “However, we caution that swinging the pendulum too far in the opposite direction may reverse our fragile recovery.”

Mr Merkley added that there was “momentum building” behind a separate amendment to prevent speculative behaviour by banks. “We need to make sure that when people go hog wild in high-risk investing they don’t damage our economy,” he said.

Separately, the Federal Reserve won its attempt to retain supervision of small and medium-sized banks with an amendment that was passed 90-9 to remove a provision that would have stripped its oversight of banks with less than $50bn (€40bn, £34bn) in assets. Presidents of the regional Fed banks lobbied heavily against the new structure.