One of the most important limitations of the [Home Mortgage Disclosure Act ] data set is that it does not include data about many of the legitimate factors lenders use to determine prices in the mortgage market, including key credit-risk factors. Credit-risk factors absent from the HMDA data set include loan-to-value ratio, consumer debt-to-income ratio, and a consumer's experience with credit. Thus, price disparities by race or ethnicity, if revealed in the HMDA data, will not alone prove unlawful discrimination. Such disparities will, however, indicate a need for closer scrutiny--a look at these other variables.

What then about the rise in bankruptcy rates and similar indicators?  Bankruptcy rates are hard to forecast, as they vary over time with changes in law and financial practice; moreover, they themselves do not tend to forecast broad economic conditions very well. One partial explanation for their recent increase, as I intimated earlier, may be the expansion earlier in the decade of the so-called subprime lending market, in which lenders sought to make loans to households whose credit histories excluded them from the mainstream market.  Although some legitimate concerns have been raised about lending abuses in this market, overall the expansion of the subprime market is a positive development, opening up as it does new opportunities for borrowers previously excluded from credit markets.  Not unexpectedly, however, lenders, borrowers, and regulators have faced a significant learning curve as this market has developed, and perhaps we should not be surprised that some of the loans made in this market in a period of strong economic growth have become distressed in a period of recession and rising unemployment.

Banks that have not understood the subprime market have had significant difficulties. To ensure that banks entering this business properly understand these risks, the agencies have encouraged banks to adopt strong risk management systems tailored to the challenges posed by these loan segments. Beyond poor risk management, there have also been instances in which certain lenders have charged fees and structured loans designed not to protect against risk, but rather to deceptively extract a borrower's net worth. Such predatory lending practices, though rare, are a cause for concern and examiners are watchful for programs that would violate the law in this regard.

From staff appendix to the Chairman's testimony

Recently a number of housing and banking agencies, including the Federal Reserve, have announced their intention to study possible restrictions on predatory lending. The Department of Housing and Urban Development (HUD) has set up a national task force on the topic. Members of Congress on both sides of the aisle have bills that limit predatory practices.

The ultimate difference between subprime and predatory lending comes back to the competitive assumptions. If one is a market optimist and believes that both lenders and borrowers are rational and well-informed, then subprime credit markets with proper rate differentials will open up. If one is a market pessimist and believes that borrowers are not well-informed and may not be fully rational, then some lenders will have opportunities to exploit these borrowers with predatory practices. Distinguishing positive subprime lending from negative predatory lending is obviously important, particularly for regulators trying to encourage one type of lending and discourage the other.

The drive to stretch traditional underwriting criteria is intensifying. Recently, there has been a boom in so-called "subprime" lending, offering a variety of types of mortgage and other loans to borrowers who have less than good credit; such lending is priced for risk and the favorable pricing of securities backed by subprime loans have found acceptance with investors...

Improved access to credit for consumers, and especially these more recent developments, reflects a good news/bad news story. The good news is that market specialization, competition, and innovation have vastly expanded credit availability to virtually all income classes. Access to credit is essential to help families purchase homes, deal with emergencies, and obtain goods and services that have become staples of our daily lives. Home ownership is at an all-time high, and the number of home mortgage loans to low- and moderate-income families has risen at a rapid rate over the last 5 years. Credit cards and installment loans are available to the vast majority of households.

The bad news is that under certain circumstances this may not be entirely good news, either for consumers in general or for lower-income communities. Along with unprecedented credit access, some problems are occurring that should alert us all to potential dangers. While every potential problem doesn't result in disaster, it's important to recognize the risks and take protective steps.

Some loans to low- and moderate-income families with multiple underwriting flexibilities, layered subsidies, and high loan-to-value ratios have been showing unfavorable delinquency and default trends. Large mortgage lenders, secondary market agencies, and private mortgage insurers are conducting studies of their portfolios to determine how more-relaxed underwriting standards are affecting delinquencies and defaults. Although more study is required to determine which risk factors are most important in particular lending situations, the results of these portfolio studies bear watching.

Although legitimate lenders may be able to manage the risks associated with the overall expansion of lending, the same may not be true of many consumers, especially those with limited means to weather a storm or who have been encouraged to borrow improvidently. Should economic or personal difficulties occur, such as the temporary loss of a job, illness, or unexpected car or house repairs, those with limited incomes and without significant savings may easily find themselves in financial trouble.