American Banker Wednesday, March 28, 2007

By Jim Cole <mailto:james.cole@sourcemedia.com>

Californialegislators are weighing responses to the subprime mortgage bubble that is fueling defaults, foreclosures, and job losses and contributing to a slowdown in the state's once-sizzling housing market.

After a two-hour hearing Monday in Sacramento, Sen. Michael Machado, the chairman of the Senate Banking, Finance, and Insurance Committee, said that beyond faster action by state regulators, he was unsure what needs to be done in California, which accounted for 14% of the nation's subprime originations in the fourth quarter, according to the Mortgage Bankers Association.

"This thing, unfortunately, is very fluid," the Linden Democrat told reporters. "We are seeing more [problems] revealed every day. I have two focuses. First of all is the implications in a macro sense to the Californiaeconomy, and then second, what can we do to try to address the problem that is there with the practitioners."

Though he said he did not have specific ideas for legislation, he took aim at the state's Department of Corporations, which regulates mortgage originators that are not governed by federal regulators. He said the department needs to use its emergency authority to clamp down on risky practices, such as marketing stated-income loans that do not require borrowers to document their sources of income.

Sen. Machado is not the first lawmaker to highlight a regulatory role in the subprime meltdown. His comments in Sacramento echoed those in Washingtonlast week by Senate Banking Committee Chairman Chris Dodd, who accused the Federal Reserve Board of contributing to the subprime mortgage crisis by encouraging the growth of alternative products and not using its power to regulate all mortgage lenders, not just banks.

Nancy Wallace, a professor at the Haas School of Business at the Universityof California, Berkeley, told the state Senate committee, "I do think the Department of Corporations in California bears some responsibility."

She also said, "When you look at corporations" such as New Century Financial Corp. of Irvine, "and you look at the thousands of brokers who were committing loans for them with very loose oversight, clearly given the performance of these portfolios, it does suggest we have holes in the regulatory oversight that could be very important."

Mortgage brokers often are also real estate brokers who are "both selling real estate and originating mortgages over the same desk to the same person," creating potential conflicts of interest that state regulators have not controlled, Prof. Wallace said.

A spokeswoman for New Century did not respond to requests Tuesday for comment.

Last month Sen. Machado introduced legislation to spur mortgage originators in the state to abide by national guidelines on nontraditional mortgages. He said he might modify that bill to address some of the issues raised in Monday's hearing, such as regulatory oversight of subprime originators.

Department of Corporations Commissioner Preston DuFauchard told the committee that he has drafted a letter asking state-regulated subprime mortgage originators to stop making stated-income loans voluntarily, and that the letter is awaiting approval from Gov. Arnold Schwarzenegger's office.

However, Sen. Machado told Mr. DuFauchard that his department is not doing enough, and that the lack of action could raise doubts in Washingtonthat the state can handle the subprime mortgage collapse.

"That's what disturbs me, because you're the entity that the folks in D.C. are saying, 'We ought to preempt, because the state is not doing the job,' " Sen. Machado said.

After the hearing, he told reporters that Mr. DuFauchard "should have been very proactive" in clamping down on risky practices by originators.

Some subprime mortgage players that are not regulated by the state are tightening the conditions for such low-documentation loans.

Wells Fargo & Co. Inc. of San Francisco has raised the minimum FICO score for stated-income borrowers by 20 points, to 640, and limited those loans to people who are self-employed. Bear Stearns Cos. has

lowered its loan-to-value requirement, so that borrowers seeking a stated-income loan must put down at least 10% of the value of a property. Previously, those borrowers needed to put down only 5%.

Sen. Machado stressed that the hearing was not aimed at assigning blame.

"I want to know what's next and what have been some of the deficiencies in the past that we can correct to go on forward," he said. "What's going to happen to California's borrowers, to our mortgage market, to our housing market, to the state's economy?"

Stuart Gabriel, a professor of finance and economics at the University of Southern California's Marshall School of Business, said, "There is a scenario here where the slow housing sector, exacerbated by subprime, can slow the economy in a fairly measureable sense."

The subprime problems will not trigger a recession nationally, Prof. Gabriel said, but reduced consumer spending and direct and indirect job losses tied to both the housing slowdown and the subprime troubles could reduce economic growth by about 2 percentage points.

State Sen. Dave Cox, R-Fair Oaks, said during the hearing that he was not convinced the Legislature should be treating borrowers losing their homes as "victims" because it could be a case of consumers who got loans that they should not have tried to get.

"It is a situation where sometimes you ask yourself, 'Can we save people from themselves?' "

On Monday morning the Assembly Banking and Finance Committee approved a bill, AB 7, to give the state the authority to enforce federal regulations on payday lending to soldiers, including the 36% interest rate cap on military payday loans. Assemblyman Ted W. Lieu, D-Torrance, the committee chairman and bill's sponsor, said that the legislation would give the Department of Corporations "the authority to shut down payday loan companies that are not enforcing the 36% rate cap for military members."