Today, the focus of the discussion has shifted from which consumers get home loans to the terms on which consumers get home loans--but the essential concern about the possible role of illegal discrimination is the same.

The enhanced ability of lenders to assess credit risk gave rise to a segment of the mortgage market often referred to as subprime lending.  In the subprime market, higher-risk borrowers pay higher prices.  Subprime lending has grown rapidly, from less than 5 percent of all mortgage lending in 1994 to an estimated 20 percent in 2005, or over $600 billion.  The wider range of loan pricing available in the subprime market helped to expand consumers’ homeownership opportunities and to increase their access to home equity.  But this same price variability has raised concerns about unequal treatment of borrowers.  It also has raised concerns about whether certain loan terms and lending practices are appropriate, whether consumers have the ability and knowledge to shop for the most beneficial loan terms, and whether the subprime market is sufficiently competitive.

The Board responded to these concerns by amending Regulation C, the regulation that implements HMDA, to expand the available data on higher-priced lending.  The data released by the FFIEC in September 2005, which covered lending activity in 2004, contained the first loan-level information on loan pricing ever available to the general public.  The data contain price information for loans whose prices exceeded thresholds set by the Board.  The thresholds were selected to target segments of the home loan market that have raised the most concern, taking into consideration the cost and burden of reporting.  The thresholds generally correspond to an unofficial line separating the prime and subprime markets.  But that line of separation is not always clear, and its correspondence with the reporting thresholds is in any event imprecise.  Therefore, we call loans whose prices exceed the reporting threshold "higher-priced loans" rather than "subprime loans."

Mortgages with some of the characteristics of nontraditional mortgage products have been available for many years; however, they have historically been offered to higher-income borrowers. More recently, they have been offered to a wider spectrum of consumers, including subprime borrowers, who may be less suited for these types of mortgages and may not fully recognize the embedded risks. These borrowers are more likely to experience an unmanageable payment shock during the life of the loan, meaning that they may be more likely to default on the loan. Further, nontraditional mortgage loans are becoming more prevalent in the subprime market at the same time risk tolerances in the capital markets have increased. Banks need to be prepared for the resulting impact on liquidity and pricing if and when risk spreads return to more "normal" levels and competition in the mortgage banking industry intensifies.

Lenders should recognize that certain nontraditional mortgage loans are untested in a stressed environment; for instance, nontraditional mortgage loans to investors that rely on collateral values could be particularly affected by a housing price decline. Investors have represented an unusually large share of home purchases in the last two years. Past loan performance indicated that investors are more likely to default on a loan when housing prices decline, than owner occupants.

The federal banking agencies have recently proposed guidance that would focus examiners' attention on those loans that are particularly vulnerable to adverse market conditions--that is, loans dependent primarily on the sale, lease, or refinancing of commercial property as the source of repayment.  I emphasize that, in proposing this guidance, supervisors are not aiming to discourage banks from making sound loans in commercial real estate or in any other loan category. Rather, we are affirming the need for each bank to recognize the risks arising from concentration and to have in place appropriate risk-management practices and capital levels.

Nontraditional mortgage products have been available for many years; however, these types of mortgages were historically offered to higher-income borrowers only. More recently, these products have been offered to a wider spectrum of consumers, including subprime borrowers who may be less suited for these types of mortgages and may not fully recognize their embedded risks.

I think it's very important to look at [option ARMs and other nontraditional mortgages]. And I believe that doing so would have on the margin some beneficial effects in reducing speculative activity in some local markets. However, overall, I think the main reason to look at these instruments is to make sure that banks are protected and that the consumers are protected against the potential risks of these instruments.

Over the past several years, there has been an explosion of new and novel mortgage products...Many of these products can be useful financial tools for homebuyers...But to the extent that these new mortgage products promote homebuying decisions that are premised on unrealistic rates of home appreciation, they raise concerns. Some borrowers may not be able to sustain such a loan over a long time horizon if the pace of home price growth moderates. In particular, when the payments on these novel mortgages adjust upward, the homebuyer may not be able to refinance such mortgages unless the home has increased in value. Homebuyers need to understand these risks and thus financial education, as well as a down payment, is a key ingredient for creating solid footing on the path to homeownership.

Predatory lending is a serious problem that needs to be addressed in a way that preserves incentives for responsible subprime lenders so that worthy borrowers with imperfect credit can become homeowners. Constricting the market by pinpointing what might be considered predatory lending and returning to a situation where some borrowers have very limited access to credit is not an ideal solution. We want to encourage, not limit, mortgage lending by responsible lenders in low- and moderate-income markets.

As the real estate lending cycle matures and lender competition increases, banking supervisors tend to worry. In particular, in the commercial and residential real estate sectors, we worry that borrowers could become increasingly speculative, buying beyond their means and hoping for asset price appreciation--whether they are buying for their own use or strictly for the sake of investment. We worry that competitive pressures could drive banks to lower their underwriting standards, implicitly encouraging such speculation. And we worry that, in the inevitable downturn, credit quality could deteriorate to the extent that some banks could experience significant losses.

The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern.

Lenders can gain an increased awareness of the lending and pricing practices of their organizations, and of their competitors, through analysis of HMDA [Home Mortgage Disclosure Act] data. As a result, lenders may take opportunities to compete in areas where the data show concentrations of high-priced lending. Competitive pressures in such markets should increase efficiency in pricing, ensuring that prices for mortgages are commensurate with risk and do not just reflect an absence of competition.

Because these important determinants of price are missing, one cannot draw definitive conclusions about whether particular lenders discriminate unlawfully or take unfair advantage of consumers based solely on a review of the HMDA data.

Supervisors have been attentive to indications that home equity lending standards and risk-management practices may not have kept up with the very rapid growth in this form of lending. Last month, the federal banking agencies issued guidance to the industry that was aimed at reinforcing sound practices for lending and credit risk management. I encourage bankers to review that guidance and consider its recommendations carefully.

The effectiveness of financial market participation as an aid to household risk management can only be fairly assessed on an ex ante basis — that is, from the perspective of before the financial transaction has been initiated...

Popular discussions of lending practices often take a decidedly ex post perspective, revolving around the consequences of particularly bad outcomes. This amounts to policy by anecdote. An ex ante approach would ask instead whether a particular practice expands the menu of borrowing options in a way that is useful to households in pursuing their economic goals.