Fed Faulted For Inaction On Mortgages

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By David Cho and Nell Henderson
Washington Post Staff Writers
Friday, March 23, 2007

Senators yesterday accused the Federal Reserve and its former chairman, Alan Greenspan, of a "pattern of neglect" that fostered a crisis in the mortgage industry that is putting more than 2 million families at risk of losing their homes.

Members of the Senate Banking Committee said the Fed had power to regulate risky lending practices but did not choose to use it even as exotic mortgages given to buyers with checkered credit helped drive up housing prices across the country. The mortgage mess has rattled markets in recent weeks and spurred a broad reassessment of lending practices.

A top Fed officer defended the agency's actions but acknowledged that it could have stepped in earlier to curb risky lending. "Given what we know now, yes, we could have done more sooner," Roger Cole, the Fed's director of banking supervision and regulation, told the committee between frequent interruptions by senators at the Capitol Hill hearing.

Greenspan, in an interview later in the day, declined to comment on whether the Fed was a lax regulator. But he disputed the senators' other allegations that he encouraged home buyers to take on nontraditional mortgages.

At one point, committee Chairman Christopher J. Dodd (D-Conn.) held up three large, blue charts demonstrating that the Federal Reserve was aware as far back as 2003 that lending standards were deteriorating.

About the same time, Dodd said, Greenspan was touting nontraditional mortgages, such as loans with adjustable interest rates that move upward after the first few years. "American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgages," Dodd quoted Greenspan as saying in a speech in early 2004.

Greenspan noted yesterday that he retreated from those remarks about two weeks after he made them, saying he meant that only "a narrow segment" of households might benefit from nontraditional mortgages.

Greenspan, who stepped down early last year, also took issue with Dodd's criticism. "To suggest the Fed was pushing subprime mortgages or even adjustable-rate mortgages is just not accurate," he said. "I was merely identifying an arithmetically obvious issue, that some mortgage borrowers, admittedly a very small segment, would do better with a different product. But I always viewed it as a very small segment of the mortgage market."

In June 2004, the Fed began a two-year campaign of raising short-term rates. This was aimed at putting a lid on inflation. But Dodd said it also hit homeowners who had loans with interest rates that adjust upward over time. While rates were going up and questionable lending practices were spreading, federal banking regulators were not "protecting hardworking Americans from unscrupulous financial actors," he said.

"In my view, these actions set the conditions for the perfect storm that is sweeping over millions of American homeowners today," said Dodd, who is running for president.

Other senators joined the fray. Sen. Robert Menendez (D-N.J.) criticized federal regulators for being "asleep at the switch." Sen. Jim Bunning (R-Ky.) asked how questionable lending practices could have spread "under Greenspan's watch."

Dodd said he was undecided whether legislation was needed to regulate subprime mortgages, loans given to home buyers with blemished credit. The market for these loans has exploded in recent years, as banks profited by packaging them as bonds and selling them on Wall Street.

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© 2007 The Washington Post Company

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