They failed to act on clues to risky loans and default rates.

(WASHINGTON) Until the boom in sub-prime mortgages turned into a national nightmare this summer, the few people who tried to warn federal banking officials might as well have been talking to themselves.

Edward Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

But when Mr Gramlich privately urged Fed examiners to investigate mortgage lenders affiliated with national banks, he was rebuffed by Alan Greenspan, the Fed chairman.

In 2001, a senior Treasury official, Sheila Bair, tried to persuade sub-prime lenders to adopt a code of ‘best practices’ and to let outside monitors verify their compliance.

None of the lenders would agree to the monitors, and many rejected the code itself. Even those who did adopt those practices, Ms Bair recalled recently, soon let them slip.

And leaders of a housing advocacy group in California, meeting with Mr Greenspan in 2004, warned that deception was increasing and unscrupulous practices were spreading.

John Gamboa and Robert Gnaizda of the Greenlining Institute implored Mr Greenspan to press for a voluntary code of conduct.

‘He never gave us a good reason, but he didn’t want to do it,’ Mr Gnaizda said last week. ‘He just wasn’t interested.’

Today, as the mortgage crisis of 2007 worsens and threatens to tip the economy into a recession, many are asking: where was Washington?

An examination of regulatory decisions shows that the Federal Reserve and other agencies waited until it was too late before trying to tame the industry’s excesses.

Both the Fed and the Bush administration placed a higher priority on promoting ‘financial innovation’ and what President George Bush has called the ‘ownership society’.

Mr Greenspan, in an interview, vigorously defended his actions, saying that the Fed was poorly equipped to investigate deceptive lending and that it was not to blame for the housing bubble and bust.

But under a new chairman, the Federal Reserve is now trying to make up for lost ground by proposing new restrictions on sub-prime mortgages.

Fed officials are expected to demand that lenders document a person’s income and ability to repay the loan, and they may well restrict practices that make it hard for borrowers to see hidden fees or refinance with cheaper mortgages.

It is an action that people like Mr Gramlich and Ms Bair advocated for years with little success.

Before this year, officials here enthusiastically praised sub-prime lenders for helping millions of families buy homes for the first time. ‘I was aware that the loosening of mortgage credit terms for sub-prime borrowers increased financial risk,’ Mr Greenspan wrote in his memoir. ‘But I believed then, as now, that the benefits of broadened home ownership are worth the risk.’

As housing prices soared in what became a speculative bubble, Fed officials took comfort that foreclosure rates on sub-prime mortgages remained relatively low. But neither the Fed nor any other regulatory agency in Washington examined what might happen if housing prices flattened out or declined.

Had officials bothered to look, frightening clues of the coming crisis were available. The Center for Responsible Lending, a non-profit group, analysed records from across the country and found that default rates on sub-prime loans soared to 20 per cent in cities where home prices stopped rising or started to fall. ‘The Federal Reserve could have stopped this problem dead in its tracks,’ said Martin Eakes, chief executive of the center. — NYT

Source: Business Times