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could be higher than suggested by the securities they backed, “could be making the
books of GSEs look better than they really were.” Fed staff replied that the GSEs were
not large purchasers of private label securities.
In the spring of , the FOMC would again discuss risks in the housing and
mortgage markets and express nervousness about the growing “ingenuity” of the
mortgage sector. One participant noted that negative amortization loans had the per-
nicious effect of stripping equity and wealth from homeowners and raised concerns
about nontraditional lending practices that seemed based on the presumption of
continued increases in home prices.
John Snow, then treasury secretary, told the FCIC that he called a meeting in late
or early to urge regulators to address the proliferation of poor lending
practices. He said he was struck that regulators tended not to see a problem at their
own institutions. “Nobody had a full -degree view. The basic reaction from finan-
cial regulators was, ‘Well, there may be a problem. But it’s not in my field of view,’”
Snow told the FCIC. Regulators responded to Snow’s questions by saying, “Our de-
fault rates are very low. Our institutions are very well capitalized. Our institutions
[have] very low delinquencies. So we don’t see any real big problem.”
In May , the banking agencies did issue guidance on the risks of home equity
lines of credit and home equity loans. It cautioned financial institutions about credit risk
management practices, pointing to interest-only features, low- or no-documentation
loans, high loan-to-value and debt-to-income ratios, lower credit scores, greater use of
automated valuation models, and the increase in transactions generated through a loan
broker or other third party. While this guidance identified many of the problematic
lending practices engaged in by bank lenders, it was limited to home equity loans. It did
not apply to first mortgages.
In , examiners from the Fed and other agencies conducted a confidential
“peer group” study of mortgage practices at six companies that together had origi-
nated . trillion in mortgages in , almost half the national total. In the group
were five banks whose holding companies were under the Fed’s supervisory
purview—Bank of America, Citigroup, Countrywide, National City, and Wells
Fargo—as well as the largest thrift, Washington Mutual. The study “showed a very
rapid increase in the volume of these irresponsible loans, very risky loans,” Sabeth
Siddique, then head of credit risk at the Federal Reserve Board’s Division of Banking
Supervision and Regulation, told the FCIC. A large percentage of their loans issued
were subprime and Alt-A mortgages, and the underwriting standards for these prod-
ucts had deteriorated.
Once the Fed and other supervisors had identified the mortgage problems, they
agreed to express those concerns to the industry in the form of nonbinding guidance.
“There was among the Board of Governors folks, you know, some who felt that if we
just put out guidance, the banks would get the message,” Bies said.
The federal agencies therefore drafted guidance on nontraditional mortgages
such as option ARMs, issuing it for public comment in late . The draft guidance
directed lenders to consider a borrower’s ability to make the loan payment when rates
