Obama Proposes Consumer Protections for Mortgages, Other Financial Products

Endless lines of fine print, hidden charges and "exploding" interest rates on mortgages could be a thing of the past under a sweeping reform of the nation's financial regulations proposed Wednesday by the Obama Administration.

The long-awaited proposal, which is designed to prevent a repeat of the circumstances that created the subprime mortgage crisis and subsequent economic crash, would create a Consumer Protection Financial Agency with authority to require minimum consumer protections on mortgages and other financial products. The proposal would also give the government new authority to intervene in troubled major financial firms whose failure would present "systemic risks" to the economy at large.

The Consumer Protection Financial Agency would play a similar role with regard to consumer financial products that the Consumer Product Safety Commission does in regard to toasters, household cleaners and other tangible products - set standards to prevent them from causing harm to consumers. In addition to mortgages, the new agency would also have authority to regulate credit cards and other loans, savings and investment products, payment services and other consumer financial products and services.

Simplified disclosure for mortgages

On mortgages, the proposed agency would have the authority to require that consumers be provided with a simplified disclosure statement that clearly lays out the costs and risks associated with a given mortgage. It could also require that consumers be offered a simplified "plain vanilla" mortgage on basic terms, with an opt-out for more complicated products only if the costs and risks associated are clearly disclosed.

In addition, the agency could require a "duty of best execution" of mortgage brokers, requiring them to avoid conflicts of interest between themselves and their borrowers, as well as ban controversial "yield spread premiums" that reward a broker for steering a borrower into a more expensive loan than they qualify for.

Prepayment penalties could be banned

The administration is also seeking to use the proposed agency to restrict or ban mortgage prepayment penalties, which discourage consumers from accelerating payments on high-interest mortgages, and to require mortgage originators - who typically sell the mortgages they make to other investors - to maintain at least a five percent interest in those mortgages, to discourage them from passing off risky loans to other investors.

Other provisions of the proposal, which addresses far more than consumer protections and mortgages, would give the Treasury Department authority to intervene in so-called "Tier 1 Financial Holding Companies" at risk of default when the failure of those firms would present a "systemic risk" to the economy, causing the failures of other large, interconnected financial companies as was triggered with last fall's collapse of Lehman Brothers and AIG.

FDIC could take over failing financial firms

The proposal would allow the Treasury Department to appoint the FDIC or SEC as a conservator or receiver for such a company, with authority to take control of the firm and transfer or sell the firm's assets. They would also be empowered to make loans, assume liabilities and inject capital. This portion of the plan is loosely modeled on the way the FDIC ensures savings accounts to protect investors and prevent the type of bank runs that led to cascading bank failures at the start of the Great Depression.

Most of the Administration's proposal will need to be approved by Congress, which is likely to make some changes, particularly in the Senate, where Republican lawmakers can use their veto threat to modify or eliminate provisions they dislike.

President Obama has indicated he would like to have the legislation passed by the end of the year, but given the size and complexity of the proposal, many observers think that is unlikely.