The Bernanke Rules for Mortgage Lending

Ben Bernanke outlined several basic consumer protection rules in a recent speech at the National Community Reinvestment Coalition’s annual meeting.

I have to give Bernanke credit for trying to strike a balance and use regulation effectively to benefit both groups: lenders and borrowers.

Here is how Bernanke framed the proposed regulations:

We believe these proposed rules will help protect mortgage borrowers from unfair and deceptive practices. At the same time, we did not want to create rules that were so open-ended or costly to administer that responsible lenders would pull out of the subprime market. So, our proposal is designed to protect consumers without shutting off access to responsible credit.

This balance of interests is a welcome shift in an administration whose guiding principle in the past could best be described as “let the markets work” or “regulations will force businesses to shut down.”

Without getting into the details, the Bernanke rules are:

• Focus on ability to pay – lenders should not lend above a borrower’s ability to pay
• Due diligence – for higher priced loans, lenders should verify assets and ability to repay
• Escrow accounts – make these accounts standard practice for the sub-prime market similarly to how they are standard in the prime market
• Ban prepayment penalties

To illustrate how confusing sub-prime loans can be, I still do not understand how banning prepayment penalties would help borrowers. This lack of transparency about the actual costs of a sub-prime loan is one of the areas where government could help through regulations.

Both consumers and lenders can win if actual costs are transparent and consumers can make informed decisions based on the costs of the loan. If costs are obscured, the lenders profit in the short term, but lose in the long term (as is happening now in the collapse of the market).

Bernanke also favors banning 7 specific advertising practices deemed deceptive. These include:

• Advertising in one language, putting fine print in another
• Advertising a fixed rate, when only the introductory rate is fixed
• Providing consumers with Truth in Lending Act information

Keep in mind Bernanke’s framing of the issue though. It is a progressive framing that regulations, when done properly, benefit both consumer and lender.