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Governor Randall S. Kroszner

Minority Depository Institutions National Conference, Chicago, Illinois
July 17, 2008

Federal Reserve's Initiatives to Support Minority-Owned Institutions and Expand
Consumer Protection
Good morning. I am delighted to be here to participate in today's discussion about how we can
work together to foster and preserve the strength and vitality of minority depository institutions.
These institutions serve essential roles. Most important, they extend credit--which is essential to
economic development and progress--to businesses and individuals in neighborhoods that otherwise
may not have ready access to loans. They also foster a spirit of entrepreneurship in their
communities, offer customized financial literacy education, and create products and services that
address their clients' particular needs. Taken together, such activities help entrepreneurs and
emerging small businesses develop and create employment, encourage the prudent and productive
use of credit, and ensure more-vibrant communities and a better quality of life.
In my remarks this morning, I will focus on two important Federal Reserve initiatives. First, I will
update you on our new Partnership for Progress program, which is designed to foster and support
minority-owned and de novo depository institutions. Second, I plan to discuss the recent
finalization of significant Federal Reserve rules implementing certain provisions of the Home
Ownership and Equity Protection Act.
Partnership for Progress
Following my promise at last year's interagency conference in Miami, I am excited to announce that
we have made good on our pledge to design a proactive training and technical assistance program
for minority depository institutions. Our initiative, known as the Partnership for Progress, was
launched nationwide on June 18. The innovative outreach and technical assistance program seeks to
help minority-owned and de novo institutions confront their unique challenges, cultivate safe and
sound practices, and compete more effectively in today's marketplace through a combination of oneon-one guidance, targeted workshops, and an extensive web-based resource and information center.
As locally focused institutions that have deep contacts with financial professionals in their regions,
the Reserve Banks have been able to ensure that we tailor the Partnership for Progress program as
closely as possible to the specific needs of the institutions participating as well as the customers they
serve. This program illustrates the advantages of the Federal Reserve System's unique decentralized
geographical structure, which consists of the Board of Governors in Washington, D.C., and the
twelve Reserve Banks that each represent a different region of the country. We also consulted with
a number of executives from minority depository institutions to better understand the unique
challenges that minority-owned depositories confront in raising capital, managing risks, and
attracting the right talent. This process has been invaluable in helping us to target our efforts and to
focus on designing a program that the minority depository institutions have told us is most crucial to
In recent months, I have had an opportunity to see firsthand the challenges that communities are
facing in various parts of the country, which has underscored to me the importance of programs like
Partnership for Progress. I have met with local community groups, bankers, housing advocates,
counseling agencies, and state and local government officials in many cities, including Atlanta,
Boston, Cincinnati, Cleveland, Las Vegas, Miami, Minneapolis, and Philadelphia. As I planned for

my participation in this conference, one example stood out. While in Atlanta, I visited a
predominantly African-American community. In this community that spanned several miles, there
were a number of vacant homes, conditions mirroring those that I have seen in other
neighborhoods. However, what was different in this case, and quite disappointing, was that not a
single financial institution was within view. This lack of local financial institution presence is a
problem that is not unique to African-American communities. Indeed, this absence occurs far too
frequently in predominantly minority communities. Our new program is intended to enhance the
vital role that minority-owned institutions can play in making financial services more available and
in providing access to credit in historically underserved communities.
At the core of our program, we have implemented a series of web-based modules designed to assist
banks in addressing three distinctive development stages: (1) starting a bank, (2) managing its
transition from a start-up to an established bank, and (3) building shareholder value once a bank has
been established on a sound footing. These easy-to-use modules are presented on the program's
dedicated website-- are available for your review and use at any
The first module of the program, "Starting a Bank," provides useful guidance on the factors that
must be considered in chartering a new bank. It includes background information that details
regulatory capital requirements, discusses the steps required to file an application, and explains the
responsibilities of a bank's board of directors. The module has video narratives of some of the key
topics to provide additional insights into, for instance, the strategic importance of strong capital for
all financial institutions. Since the program was launched, "Start a Bank" has been among the most
popular pages on the website.
The second module, "Managing Transition," focuses on the benefits that a bank can derive from
well-planned growth. Because maintaining competitive products and services is a very important
aspect of managing growth, we have included a video clip on how minority depository institutions
can use the natural branding inherent in their mission to stay ahead of the competition and
differentiate themselves. This module provides some examples of approaches and strategies to
establishing a bank that have been successfully followed by other new institutions to achieve stable
and profitable performance.
The third and final module, "Growing Shareholder Value," is designed to help more-mature
institutions achieve an even stronger financial footing and improve shareholder value. This module
addresses key topics, such as corporate governance and performance measurement, that can help to
ensure that management remains on target with the overall goals of the organization. Given that
most minority depository institutions are at this stage of life-cycle development, we expect the
topics in this segment, such as "Demographic Analysis," "New Product Implementation," and
"Outsourcing and Vendor Management," to be particularly useful.
We expect minority institutions will use the program to help them navigate three of the most
challenging periods in the life cycle of any financial institution. I expect that the program, which
draws on insights from economics, accounting, finance, and regulatory compliance, will become a
valuable resource for institutions at different stages of their development. In order to further expand
the support that we can offer to these institutions, the Federal Reserve also plans to conduct periodic
training sessions for interested participants that will address topics of particular concern and
relevance to minority depositories and their bank holding companies.
We also have designated Partnership for Progress contacts in each of the twelve Reserve Bank
districts and at the Board to answer questions and coordinate assistance for institutions requesting
guidance.1 I hope that you will consider contacting us for support or to provide additional
suggestions for improving this evolving program. We are pleased with the initial feedback we have
received since the program's launch and will continue to fine-tune and enhance the program over
time. In that respect, we look forward to continuing to work with you to make this exciting program
even more effective.

Home Ownership and Equity Protection Act
I would now like to turn to important new consumer protections that the Federal Reserve Board
adopted earlier this week. These new rules, which implement HOEPA, were put into place to
protect consumers and to help prevent a recurrence of the problems that we are now facing. The
current wave of foreclosures is taking a very real toll on families and their communities, no place
more so than in predominantly minority communities, where subprime loans were particularly
The U.S. mortgage market has seen rapid innovation in recent years. Changes, such as automated
underwriting models, the evolution of the secondary markets, and specialization, have had many
positive effects. Some changes in practices, however, have not been so salutary. Abusive loans that
strip borrowers' equity or cause them to lose their homes should not be tolerated. Too many
homeowners and communities are suffering today because of these practices, and the Federal
Reserve Board's rules will better protect consumers while preserving their access to credit as they
make some of the most important financial decisions of their lives.
Last December, the Board proposed changes using our authority under the Home Ownership and
Equity Protection Act. In formulating that proposal, the Board sought a wide range of input and
information through hearings and meetings throughout the country. In response, we received, and
considered, over 4,500 comment letters sent to us from community groups, industry participants,
consumer advocates, and other interested individuals. We engaged in outreach to commenters to get
clarification of their concerns and weigh competing viewpoints. We gathered available data and
conducted updated analyses. We undertook on-the-ground consumer testing, which has proven to
be an invaluable tool for us in determining policy effectiveness, to gauge the practical effects of one
of the proposed rules on individual consumers. Listening carefully to the commenters, collecting
and analyzing data, and undertaking consumer testing, I believe, have led to more-effective and
improved final rules.
Our goal throughout this process has been to protect borrowers from practices that are unfair or
deceptive and to preserve the availability of credit from responsible mortgage lenders.
These rules expand upon interagency guidance issued last year on subprime loans. That guidance,
however, only focused on certain specific subprime products, hybrid adjustable-rate mortgages, such
as so called 2/28s and 3/27s, and only applied to federally supervised institutions. Our rules now
apply much more broadly to cover all higher-priced mortgages, including virtually all closed-end
subprime loans secured by a consumer's principal dwelling, and to all mortgage originators. These
rules also cover a broad range of issues:
lenders' assessment of consumers' ability to repay loans,
lending with little or no documentation of income,
prepayment penalties,
escrow accounts for property taxes and insurance,
mortgage servicing practices,
coercion of appraisers,
misleading or deceptive advertising practices, and
disclosure of Truth-in-Lending cost disclosures early enough to help consumers shop for a
I'd now like to focus in more detail on some key features of this wide-ranging set of rules and
discuss a few of the most important changes that we have made since our proposal this past

December because I think they are illustrative of how we approached these issues.
On one issue, loan affordability, we proposed a rule that would have required a lender to make sure
that a borrower could afford the monthly payments before a loan is made. This step sounds like
common sense, but unfortunately, as some loan originators pushed off more and more of the risk to
investors, they made increasingly riskier loans to people who simply could not afford them. So we
proposed a rule to address that problem, and it spelled out how a lender should assess this ability to
repay, building on the earlier interagency guidance on subprime loans. Lenders would have violated
the proposed rule if they engaged in a pattern or practice of making loans without considering
consumers' repayment ability.
During the public notice period, we received a number of comments on the "pattern or practice"
element of the proposed rule, and we conducted further outreach to both consumer advocates and
industry participants. Many advocates objected to this heavy burden of proof, calling into question
the effectiveness of the intended consumer protection. Some mortgage lenders, however, suggested
that the "pattern or practice" provision did not provide a safe harbor that would ensure compliance
and that their procedures for compliance would, by necessity, be equally robust under either version
of the rule. At the end of the day, we agreed that this provision would have limited the intended
effectiveness of the rule and that removing it, along with clarifying other requirements, would not
impede the availability of credit to borrowers. Accordingly, the final rule establishes a lender's
responsibility to assess a borrower's ability to repay on every loan originated, effectively giving
wronged consumers a private right of action without demonstrating that their case was part of a
broader pattern.
In addition, the new rule requires that the lender take into account future, predictable changes in
payments in determining repayment ability. A lender complies, in part, by assessing repayment
ability based on the highest scheduled payment in the first seven years of the loan. For example, on
a 5-1 ARM with a payment for the first five years based on a discounted interest rate, the lender
would use the scheduled payment in the sixth and seventh years, which is based on the fully indexed
Another element of our proposal that received many comments was a rule limiting prepayment
penalties. On the one hand, numerous commenters argued that prepayment penalties can result in
lower interest rates paid by the borrower. Although there are exceptions I will mention in a
moment, a number of studies have found that loans with prepayment penalties carry lower rates or
annual percentage rates (APRs) than loans without prepayment penalties having similar credit risk
characteristics.2 On the other hand, the rate benefit was called into question by many, who asserted
that prepayment penalties may lock borrowers into unaffordable loans, particularly adjustable-rate
loans whose payments may change dramatically. Prepayment penalties were also criticized because
of the way they reinforce another potentially abusive practice--yield spread premiums, or YSPs.
Some lenders' rate sheets show that mortgage brokers can earn bigger YSPs, which are essentially
commissions, by increasing consumers' interest rates, and the biggest increases are allowed only if a
loan contains a prepayment penalty.
After an exhaustive analysis of the issue and all available data, the Board concluded that the costs
and benefits of prepayment penalty provisions on higher-priced mortgages depend, to an important
extent, on the structure of the loan. It has been common in the subprime market to structure loans to
have a short expected life span. This aim has been achieved by building in a significant payment
increase just a few years after loan consummation. With respect to subprime loans designed to have
shorter life spans, the injuries from prepayment provisions are potentially the most serious as well as
the most difficult for a reasonable consumer to avoid. Moreover, according to research, the rate
reduction for a prepayment penalty provision on such short-lived loans is smaller and, in absolute
terms, quite limited. For these loans, therefore, the Board concluded that the injuries caused by
prepayment penalty provisions outweigh their benefits, and we did ban them for these loans-specifically, loans in which the principal-and-interest payment can change within the first four

With respect to subprime loans structured to have longer expected life spans, however, the Board
concluded that the potential for harm from prepayment penalties is lower relative to potential
benefits, warranting restrictions but not a ban. Our analyses indicate that for fixed-rate loans,
borrowers can obtain meaningful interest-rate reductions on loans that contain provisions for
prepayment penalties, and performance on these loans has typically been superior. These factors
generally reduce the negative impact of prepayment penalties, so for these loans, we added a
restriction limiting the length of the prepayment penalty period to no more than two years.
Another change has to do with how we define the loans that we most want to cover. Our principal
goal was to cover the vast bulk of the subprime market, where most of the problems have been and
where consumers may need the most protection. The challenge is that there is no one accepted
definition of what makes a loan "subprime."
We anticipated, and received, a number of comments about this problem and sought solutions. We
looked at available sources of data on mortgage rates and concluded that the best source for our
purposes is a survey called the Primary Mortgage Market Survey®, published by Freddie Mac. The
Federal Reserve will publish our own index, called the "average prime offer rate," that will be based
on Freddie's survey and other market data, and if we need to adjust the index over time, we can. We
will still cover nearly all of the subprime market plus a sizable fraction of the so-called Alt-A
market, as we intended with our initial proposal, but the new approach will do so in a more accurate
and consistent way, and therefore better ensure that we protect at-risk consumers without impinging
on the prime market.
Protecting borrowers with responsible underwriting standards can also provide a broader benefit of
enhancing the integrity and proper functioning of the mortgage market by increasing investor
confidence. Ensuring that ability to repay by underwriting and documenting income, for example,
can help to reduce investor uncertainty about the performance of mortgage-backed securities.
Effective consumer protection thus can produce a complementary benefit for consumers by helping
to revive mortgage funding markets and potentially improving credit availability.
Finally, I'd like to highlight one other change that shows how hard it can sometimes be to craft
solutions that work. In December, we proposed a rule that we hoped would address some of the
problems posed by YSPs. The heart of the rule involved an agreement that the broker and borrower
would sign early on that would spell out the broker's compensation and how they are paid.
As the public comment period was under way, we began consumer testing to see how this process
would actually work. We engaged a firm that specializes in this testing and conducted a rapid round
of tests this spring with individual consumers. The firm developed and tested a form in which the
broker would agree to total compensation and make certain disclosures that we thought would help
consumers make informed decisions. Throughout the testing, revisions were made to the form in an
effort to improve comprehension. The testing revealed two problems.
The first problem is that many participants believed, after reading the disclosure, that the broker
would be obliged to find them the lowest interest rate and best terms available, which is not true.
The second problem was that many participants came to believe that working through a broker
would cost them more than working directly with a lender, which is not necessarily true either. The
firm tried to correct these misunderstandings, but no matter what it did to change the language, the
forms continued to confuse consumers more than inform them.
Our consumer testing led us to the conclusion that our approach was not serving its intent--that is, to
better inform consumers. We are continuing to try to find an approach that would be effective, but
we did not want to hold up all the other consumer protections while we worked on it. As a result,
we decided to withdraw the proposed provision on mortgage broker compensation, and we will
continue to explore other approaches as part of the ongoing update of our mortgage rules already
under way. Some may have preferred that we stick with our proposal, but creating a rule that
informed consumers in theory, but only served to confuse them in practice, would have helped no

In closing, I would like to underscore the Federal Reserve's commitment to preserving and
supporting minority depository institutions. I look forward to continuing our constructive dialogue
on finding the best and most practical ways to address the challenges that these banks confront. I
am confident that we will be successful in ensuring that these companies remain strong and continue
to provide critical financial support to their communities.
I also want to stress that finalizing our HOEPA rules does not represent the end of our efforts to
improve transparency and consumer protections in mortgage lending. We will continue to work
diligently to determine how best to address the issue of yield spread premiums. Further, we will
collaborate with our partner agencies to enforce these rules and to monitor their impact on the
market to ensure that they are effective in achieving their goals of protecting borrowers from
abusive practices and preserving the availability of credit from responsible mortgage lenders.

1. On the Partnership for Progress program website. Return to text
2. Chris Mayer, Tomasz Piskorski, and Alexei Tchistyi (2008), "The Inefficiency of Refinancing:
Why Prepayment Penalties Are Good for Risky Borrowers (357 KB PDF)," ; Gregory
Elliehausen, Michael E. Staten, and Jevgenijs Steinbuks (2008), "The Effect of Prepayment
Penalties on the Pricing of Subprime Mortgages," Journal of Economics and Business, vol. 60
(Jan.-Feb.), pp. 33-46; Michael LaCour-Little (2007), "Prepayment Penalties in Residential
Mortgage Contracts: A Cost-Benefit Analysis," unpublished paper, January; Richard F. DeMong
and James E. Burroughs, (2005), "Prepayment Fees Lead to Lower Interest Rates (64 KB PDF),"
; but see Keith S. Ernst (2005), "Borrowers Gain No Interest Rate Benefits from Prepayment
Penalties on Subprime Mortgages," research report, (Durham, NC: Center for Responsible Lending,
January), Return to
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