Reactions to the Fed's Subprime Solution

Yesterday's announcement that the Federal Reserve endorsed new rules for lenders of subprime mortgages, which includes banning low-documentation loans and setting limits on penalties for borrowers who want to repay their loans early, set off a debate about how effective the plan would be -- and who would really benefit from it.

Some experts say the proposed changes to the Regulation Z (Truth in Lending) and the Home Ownership and Equity Protection Act will not help to repair the failing housing market, but will just benefit lenders and lock-out some buyers. Others say homeowners should be encouraged by the plan.

"Eliminating the prepayment penalties is great," says Steve Habetz, president of Threshold Mortgage in Westport, Conn. "Individuals that are ready to refinance out of these loans now can't because prepayment penalties make it very difficult for them to refinance. I've seen prepayments be as much as 5%. That changes the loan to value and makes it impossible to get out."

The Fed's proposal should eliminate such a bind in the future, but should people who didn't carefully read their mortgage contracts before signing them be bailed out? Yes, says Habetz. "Yes, people sign things when they don't completely understand them" -- just look at the three-page document you signed to get your gym membership, he says -- "but that's why people should have an independent source to go to for reliable information."

Regardless of industry, there have always been informed consumers and there have always been those who didn't take full advantage of their resources -- after all, that is what fuels the "Buyer Beware" mentality. It works itself out in the end without intervention, say some.

"Markets correct themselves without, and often despite, government's 'help,'" says Chuck Webber, a partner with Faegre & Benson who represents financial institutions. He believes that amid this subprime crisis, government regulation may do more harm than good for buyers with lower credit scores or hard-to-track income.

"Making it tougher for lenders to make loans means they will make fewer loans. And the loans they do make will go only to the well-to-do and people with perfect credit," he says. "That will take us right back to the environment that created the need for subprime lending in the first place. Less-than-perfect borrowers--the very people the government set out to help--will go back to having little ability to get credit."

University of St. Thomas professor Tom Musil agrees with Webber, but takes a positive spin on the tightening of lending to the less-than-perfect borrower.

"There will be fewer buyers if verification of income is required," says Musil, who is the director of a real estate appraisal program at the Minneapolis university's business school. "If [a consumer] didn't have an income and couldn't support the debt to income ratio they wouldn't get a loan. In the end, there will be a greater ratio of qualified buyers obtaining loans and people couldn't get into trouble. [The Fed's proposal] promotes solid lending criteria."

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