Guidance on Nontraditional Loans Focuses on Lender Practices.

New York -- At the Regulatory and Legislative Roundup at the MBA National Secondary Market Conference here, Scott Polakoff, deputy director and chief operating officer, Office of Thrift Supervision, discussed the nontraditional guidance that came out in 2006 and the statement on subprime mortgage lending, which is now being debated by federal regulators before it comes down to the final reform.

Regulators have a responsibility for looking at practices not products, Mr. Polakoff said. "That is so important. It is very common for the industry, for regulators, for Congress, to focus on a product. To say that product is good, that product is bad."

That is not the right approach, he added. "For example, nontraditional mortgages. Are they good or bad? They can be an outstanding tool when used properly or a devious tool when used improperly. How about 2/28 hybrid ARMs? Good or bad? It depends."

Risk layering is part of the problem that got the industry where it is now, and it should help get lenders and servicers out of the problem in the short term. As subprime ARMs reset in 2007, there will be the potential for tighter underwriting, and static or declining home values will effect refinancing, said Mr. Polakoff.

There is a philosophical switch in the way servicers are setting protections for the loans. Before, they used to foreclose as soon as possible, he said. "Now we try and keep people in their homes, which requires a lot of work and outreach from financial institutions. It's surprising to see that first-time homebuyers are likely to go into default, because they are stretched financially, in a home they can't afford, and they have no idea what's involved with buying a home for the first time."

It looks like securitizations in the pooling and servicing agreements allow for modifications on either delinquent or reasonable, foreseeable delinquency. It used to be a lot of people tried to avoid certain levels of debt. Now the debt level is actually considered as a purchasing opportunity, he said.

Regarding the subprime market and the emergency guidance issued in 2001, Mr. Polakoff asked everyone in the room to consider their definition of "subprime," predicting there would be 50 or 60 different variations, including characteristics of FICO scores. The guidance addresses underwriting criteria, consumer protection and policies and procedures.