Update from the Federal Reserve
By Mark Hewitt
President and CEO
Clear Lake Bank & Trust Company, Clear Lake
As a member of the Board of Directors of the Federal Reserve Bank of Chicago, I am often asked about the challenges facing the U.S. economy. The housing market crisis that started last year and leaked into the financial markets has kept Fed policy-makers quite busy. I’d like to share information on three areas where the Federal Reserve has been very active in recent months responding to a rise in delinquency and foreclosure rates and trying to ease stress in the markets.
Passing of the Home Ownership Equity Protection Act
In response to substantial increases in delinquency and foreclosure rates on sub-prime mortgages, the Federal Reserve Board approved a final rule amending the Home Mortgage Provisions of Regulation Z (Truth in Lending). The new rule was adopted under the Home Ownership and Equity Protection Act (HOEPA) in response to abusive practices in the mortgage markets, such as prepayment penalties and loans that exceed borrowers’ equity and ability to repay.
The new rule establishes a new category of “higher-priced mortgages” secured by a consumer’s principal dwelling. For these higher-priced loans, the lender:
- Is prohibited from making a loan without regard to borrowers’ ability to repay the loan from income and assets other than the home’s value.
- Is required to verify the income or assets it is relying on to determine repayment ability.
- Can’t assess any prepayment penalty if the payment can change during the initial four years.
- Must establish an escrow account for the payment of property taxes and homeowners’ insurance for first-lien loans.
For loans secured by a consumer’s principal dwelling, regardless of whether the loan is higher-priced or not:
- Creditors and mortgage brokers are prohibited from coercing a real estate appraiser to misstate a home’s value.
- Servicing companies are prohibited from: (1) not applying payments as of the date the payment is received, and (2) failing to provide a payoff statement within a reasonable timeframe, and (3) applying pyramiding late fees.
For all mortgages, HOEPA established advertising standards — mortgage advertising is required to contain information about rates, monthly payments, and other features. Furthermore, HOEPA prohibits deceptive advertising such as representing that a rate or payment is “fixed” when it can change.
HOEPA takes effect on October 1, 2009, while the escrow requirement will be phased in during 2010.
Providing Foreclosure Information
At the Federal Reserve Bank of Chicago, several efforts are underway to reach troubled borrowers, raise awareness about foreclosures and provide information on how to mitigate the impact of foreclosures in neighborhoods. The Neighborhood Housing Services’ (NHS) Home Ownership Preservation Initiative (HOPI) and the Federal Reserve Bank of Chicago have been hosting conferences around the District that focus on what causes foreclosures at the regional level and how to prevent them. Additionally, the Federal Reserve Bank of Chicago just launched a new foreclosure resource center Web site that provides information to help prevent foreclosures and reduce the impact on neighborhoods. Additional information on the conferences and the Web site can be found at www.chicagofed.org/community_development.
Supplying Liquidity to Financial Markets During Times of Crisis
Since September 2007, the Federal Reserve has taken a number of steps to provide liquidity and foster the smooth functioning of financial markets. Here is a quick overview of each of the Fed’s liquidity operations.
Discount Window
Historically banks have been reluctant to use the discount window for fear that it would signal some operational miscalculation. To encourage use of the discount window and mitigate the historical stigma, the Fed reduced the wedge between the primary credit rate and the fed funds rate from 100 basis points to 25 basis points and allowed borrowing for terms of up to 90 days.
Term Auction Facility (TAF)
The Fed also instituted the TAF, which is an alternative market-based auction system for depository institutions to borrow at term from the window. The TAF allows banks to borrow against a broader range of collateral not widely accepted in private markets—such as securities--thus meeting the needs of liquidity strains.
Term Securities Lending Facility (TSLF) and Primary Dealer Credit Facility (PDCF):
Both of these liquidity facilities are for securities and primary dealers. Since primary dealers, which include several investment banks, are non-depository institutions, these loans required the Fed to invoke its authority to lend to non-banks under section 13(3) of the Federal Reserve Act. Under this act, such lending is only permissible under “unusual and exigent circumstances.”
To learn more about these lending facilities, log on to http://www.newyorkfed.org/markets/Understanding_Fed_Lending.html.
Conclusion
While the U.S. economy is facing difficult challenges, the Fed has taken action to help consumers, businesses, and the economy. HOEPA should support sustainable homeownership by making credit available to qualified borrowers, and it should protect consumers from unfair lending practices. The Fed has also promoted efforts to raise awareness about foreclosures and provide information to consumers and neighborhoods.
Finally, the Fed has created lending facilities to increase market liquidity by lengthening lending terms, reducing the cost of borrowing relative to the fed funds rate, expanding the range of eligible counterparties, and enlarging the pool of eligible collateral.
Mark Hewitt has served as a member of the Federal Reserve Bank of Chicago Board of Directors since January. He is President and CEO of Clear Lake Bank & Trust Company in Clear Lake and will be inducted as an at-large member of the Iowa Bankers Association’s Board of Directors at the IBA Annual Convention later this month.
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