Legislation Seeks to Limit Creative Mortgages

The subprime loans, exotic mortgages and endlessly repackaged securities that gaive rise to the housing bubble are a thing of the past. New legislation now making its way through Congress seeks to ensure that they stay that way.

A bill being promoted by House Financial Services Committee Chair Barney Frank (D-MA) would put new limitations on the types of mortgages that can be issued and restrict the commissions that brokers could collect on exotic loans. The legislation is intended to tighten up the requirements for obtaining a mortgage and prevent borrowers from getting into loans they are unlikely to be able to repay.

The legislation, which is considered a fairly safe bet to pass in one form or another, means that mortgage lending is likely to return to the more straightforward types of loans that dominated in the past. Adjustable rates, balloon payments, second mortgages for down payments and similar instruments may not disappear entirely, but will be largely overshadowed by the plain, old-fashioned 30- and 15- year fixed mortgages.

The mortgage industry will seek some changes in the legislation as currently written, but is not expected to oppose it outright. There appears to be consensus that some changes are needed to allow the market to recover.

"The proposal could serve to rebuild trust in the mortgage profession," says Francis Creighton, chief lobbyist for the Mortgage Bankers Association, told the Kiplinger Letter. "It would make consumers feel confident there are real standards."

By curtailing the volatility of the housing market however, the new rules would also serve to dampen any recovery in housing prices. Just as exotic financial instruments helped drive the increase in prices that led to the development of the housing bubble, eliminating or severely curtailing such instruments means less upward pressure on housing prices and a slower recovery.

To help prevent loan originators from targeting high-risk borrowers, Rep. Frank is pushing a clause that would require original lenders to maintain at least a 5 percent stake in any mortgage they issue. However, it is uncertain whether that provision will make it to the final version, as smaller mortgage banks in particular would find it burdensome, given the limited capital they have to work with.