Midnight at the Regulators' Ball

In a speech made back in December 2005, John C. Dugan, Comptroller of the Currency warned that Option ARMs posed a threat to consumers and to lenders.  I was thrilled that this problem, which responsible professionals have been worrying about for years, finally came to the attention of regulators. I wrote an article about this back then, some 15 months ago.

Well, they have FINALLY gotten around to announcing that they "might" do something about it.  The problem is being addressed by a task force made up by officials from the following government agencies:

• Office of the Comptroller of the Currency, Treasury (OCC)
• Board of Governors of the Federal Reserve System (Board)
• Federal Deposit Insurance Corporation (FDIC)
• Office of Thrift Supervision, Treasury (OTS)
• National Credit Union Administration (NCUA)

The task force has issued a combined press release inviting comments from interested parties. You can see their entire announcement online here.

Maybe taking 15 months to announce possible action is fast by Washington standards, but it's an action that is long overdue. In the task force press release they identified the following problems:

• Initial period then adjusts to a variable index rate plus a margin for the remaining term of the loan;
• Approving borrowers without considering appropriate documentation of their income;
• Setting very high or no limits on how much the payment amount or the interest rate may increase ("payment or rate caps") at reset periods, potentially causing a substantial increase in the monthly payment amount "payment shock"
• Containing product features likely to result in frequent refinancing to maintain an affordable monthly payment;
• Including substantial prepayment penalties and/or prepayment penalties that extend beyond the initial interest rate adjustment period; and/or
• Providing borrowers with inadequate information relative to product features, material loan terms and product risks, prepayment penalties, and the borrower's obligations for property taxes and insurance.

I am pleased that they are taking action but don't think that anything serious is liable to happen, depending upon who takes action and what lenders are regulated. I am not sure who regulates whom but I think that mostly they are talking about Federally Chartered Banks that, in my opinion have not been the biggest offenders in the business. In fact, some big banks who fall under their scrutiny never have offered Option ARMs, figuring out at the management level that they just didn't want to play in that ball park.  Good for them.

I think that the worst abusers of borrowers are among the subprime lenders who are (probably or possibly) not regulated by these people anyway.  So any rule-making they come up with will not apply to anyone they don't regulate.

That doesn't mean that something more can't happen. What I hope for is that, regardless of regulatory oversight, Wall Street sources that have been buying these loans from subprime lenders shut off the tap of money. The ballooning risks of that market are going to come home to roost with higher default rates and greater losses.  That will shut down those practices in a hurry.