Tuesday (July 8), Federal Reserve Chairman Ben Bernanke finally shared some of the details about new Fed plans to crackdown on some of the deceptive and unethical home lending practices that most believe have contributed to the housing and credit mess. Largely a response to demand from Americans and law makers, the Fed wants to address practices related to sub-prime and exotic lending that made lending too easy during the housing boom of the early 21st century.

Outraged members of Congress have gone as far as to call the current credit crunch the worst in generations. Many believe a lack of government regulations during the housing boom made it too easy for borrowers to borrow irresponsibly, and for aggressive lenders to take advantage of desperate consumers. The Fed hopes to prevent another credit crisis from developing once the financial sector works its way out of the current one.

The biggest sufferers from the credit problems have been sub-prime and low income borrowers who took on loans with low costs up front, but skyrocketing interest after specific periods of time. After the balloon payment adjustments, unmanageable payments for homeowners have resulted in record foreclosures that continue to climb. As a domino effect, sub-prime and aggressive creditors have faced a lack of capital and record low profits from an inability to collect on debt from failed mortgages.

Among the new rules addressed by Bernanke were: Restrictions on early loan repayment penalties which inhibit borrowers who want to responsibly pay off loans early, requirements that force lenders to ensure borrowers have money for taxes and insurance, and expectations that lenders confirm a borrower’s ability to repay a loan.

The details of the new rules are not finalized but the premise of the tightened regulations is to remove the lax borrowing conditions that allow borrower’s to take on more debt than they can manage and lenders to be just as irresponsible in giving it to them. Interestingly, some have suggested the proposed regulations do not go far enough to protect consumers. Others argue that it is a lack of consumer responsibility that is the problem and that it is unfair to over regulate creditors and restrict lending opportunities.

Consumers benefited greatly in the short-term during the housing boom of 2001-2005. Great access to a diverse range of loans made credit more usable as leverage to buy real estate. Former Federal Reserve Chairman Alan Greenspan has been criticized for allowing the loose lending environment to go on without an attempt at intervention. Unfortunately, the medium to long-term repercussions in the credit and housing markets have been deeply felt.

Bernanke’s comments Tuesday came coincided with news from the National Association of Realtors that the May pending home sales index dropped 4.7 per cent. This was the third lowest drop in the index in its history. The data reflects the general consensus that housing and financial markets are not necessarily out of danger.

Along with the announcements about the pending regulations, Bernanke also indicated that the Fed was considering extending opportunities for struggling Wall Street firms to utilize the Fed’s emergency loan program. Assisting creditors to make capital more available is considered an important part of the credit recovery process by many.

Market Recap

Monday was a volatile trading day for equities. The Dow dropped 56 points after being up over 100 points earlier in the day. The NASDAQ dropped 2 while the S&P lost 10 points. Financial sector trouble and disconcerting comments from a Fed official led to the downward move. Stocks did a complete 180 and then some on Tuesday. Equities started the day negative this time and turned positive in a hurry during afternoon trade. A drop in oil and soothing news on the financial sector calmed Monday’s nerves. The Dow jumped 152 while the NASDAQ and S&P were up 51 and 21 points. Treasury Secretary Paulson expects foreclosures to remain high for a while.

Neil Kokemuller
Tuesday, July 8, 2008
10:34 PM EST

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University.

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