By Dave Clarke
WASHINGTON (Reuters) - U.S. banks still wrestling with legal troubles springing from the subprime mortgage crisis are lobbying the new consumer agency for strong legal protection for future home loans.
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The Consumer Financial Protection Bureau is finalizing a proposal to entice banks to offer straightforward loans -- without interest-only payments and excessive fees -- by providing a legal shield. The question is whether to give banks full protection, known as a "safe harbor," or a more limited legal shelter.
"It is critically important that the final rule provide a safe harbor," Bank of America Corp
The Federal Reserve issued a proposed rule on the matter earlier this year, but then punted it to the consumer agency, which now has jurisdiction. The agency, which was created by the Dodd-Frank oversight law, opened its doors on July 21.
This rule will be one of the first big tests of how tough the consumer agency will be on mortgage markets.
Those banks and others are hobbled by stalled foreclosures nationwide due to legal questions and multibillion-dollar lawsuits from investors such as American International Group Inc <AIG.N> that claim the quality of securities backing the mortgages was misrepresented.
The banks argue the safe harbor for future high-quality loans would promote lending and assure investors who buy mortgage-backed securities that legal battles are not on the horizon.
On the other side of the issue, consumer advocates charge banks want to take away one of the few legal tools available to borrowers who believe a lender pulled a fast one on them.
"The bureau's position on this rule will be an indicator of its ability to work independently of the bank lobby," said Alys Cohen, a staff attorney for consumer advocacy group the National Consumer Law Center.
The consumer agency is expected to issue a final regulation by early next year.
An agency spokeswoman declined to comment.
SIMPLE CONCEPT, TRICKY LEGAL QUESTION
The rule is required by the 2010 Dodd-Frank financial oversight law passed after lenders in the lead up to the financial crisis extended billions of dollars of high-risk mortgages to high-risk borrowers.
When it issued the proposed rule earlier this year, the Fed said the law was unclear about what legal protection should be given to these loans and asked for comment on two suggestions. The first is a legal safe harbor, while the second would give a borrower more latitude to challenge whether a bank did all it should to comply with the law.
The consumer bureau does not have to take an either-or approach on the proposals offered by the Fed. It could, for instance, choose a compromise solution such as beefing up the underwriting standards a loan would have to meet if it goes for the safe harbor option.
Banks warn that, when making a final decision, the agency should keep in mind the last thing the fragile housing market needs is less certainty about loans.
"Any further contraction caused by undue litigation risk will exacerbate these problems," JPMorgan Chase wrote last month.
Consumer groups say banks overstate the risks and fall back on their warning that credit could be restricted.
"They always say this will dry up the market," Kathleen Keest of the Center for Responsible Lending said. "As I like to remind them, the first time it dried up was when they were free to do what they want."
(Reporting by Dave Clarke; editing by Andre Grenon)