The Federal Reserve has decided not to proceed with new rules that would limit a consumer's right to escape a fraudulent mortgage, choosing instead to cede the authority to the newly forming Consumer Financial Protection Bureau (CFPB).

The move is being cheered by consumer advocates, who say the proposed rule would have effectively eliminated a mortgage borrower's right of rescission, the right to cancel a loan sold under misleading or false pretenses.

As part of the same move, the Fed also announced today that it is cancelling plans to implement new rules on reverse mortgages and to require new consumer disclosure rules on mortgage and home equity loans, choosing instead to leave these tasks to the CFPB as well. All of the proposed rules would implement parts of the Truth in Lending Act (TILA).

The right of rescission gives a borrower up to three years to seek legal action against a borrower who issued a mortgage under false or demonstrably misleading pretenses - for example, failing to disclose certain fees or misrepresenting the interest rate. A borrower who wins such a case is freed from paying all interest and fees to the lender, but is still obligated to repay the loan principal.

The borrower is supposed to be protected against foreclosure in such cases. However, opponents of the rule proposed by the Fed said it would have still allowed lenders to foreclose at any time up until the principal was paid off, effectively eliminating the protection. Advocates for the rule from the mortgage industry said it would have provided much-needed clarity to rescission proceedings.

By handing the rulemaking authority off to the CFPB, the Fed is giving the task to an agency that was created explicitly to look out for consumer interests. The Bureau's creation is being overseen by Elizabeth Warren, an outspoken consumer advocate who first floated the idea for an agency to protect consumers in financial transactions and who has been a sharp and frequent critic of the mortgage industry.

Other rules being deferred to the CFPB by the Fed action including restrictions on certain marketing practices for reverse mortgage, new disclosures for loan modifications and the adoption of new single-page disclosure forms for mortgage loans.

The Fed said it was taking the step because the rules would not be finalized until after July 2011, when rulemaking authority for TILA is scheduled to transfer to the CFPB, and so proceeding with implementing the new rules at this point would not be in the public interest.

Published on July 19, 2008