Updated 2/2/2011: This news report is regarding a proposal from the Federal Reserve to modify existing rules for a homeowner’s right of rescission. On February 2, 2011 the Fed issued a press release stating this proposal will not be enacted by the Fed and will fall under the purview of the Bureau of Consumer Protection for further review after July 2011.

The Federal Reserve (the Fed) is forging ahead on a substantial revision of the Truth in Lending Act (TILA) despite great public consternation.

Since 1968, when TILA was first enacted in the U.S., a homeowner’s right to rescind a fraudulent home loan has been the most effective weapon for fighting foreclosures. The Fed is seeking to limit the right by revising this portion of TILA before the right of rescission comes under the purview of the Bureau of Consumer Protection in 2011. [For more TILA updates, see the first tuesday Legislative Watch for October 2010, November 2010 and December 2010.]

Currently, homeowners have up to three years after the origination of their home loan to force their lender to rescind if they can prove any terms or conditions were improperly disclosed. Should a lender be forced to rescind, the homeowner is still responsible for paying back the principal on the loan, but may be able to refinance with another lender in order to do so, despite the fact their home is in foreclosure.

Although the right to rescind has always existed under TILA, the multitude of homeowners currently threatened with foreclosure and unable to refinance are turning to rescission as though it is a panacea in the hopes they will be able to retain their home.

The Fed is concerned the right of rescission, as it currently stands, is leading to frivolous law suits which waste taxpayer dollars and adversely affect the strength of the economic recovery by delaying foreclosures indefinitely. [For more information on the progress of the economic recovery, see the November 2010 first tuesday article, Economic Forecast Conference points to a long period of recovery for California’s real estate market.]

In order to limit the likelihood of a homeowner seeking an unwarranted or frivolous mortgage loan rescission, the Fed is proposing the homeowner payoff the principal balance on the loan as a condition of the lender releasing its lien. Although the Fed is not revoking the right of rescission, this limitation essentially renders the right impotent — a homeowner in foreclosure needs financing from another lender in order to pay off the principal on the rescinded loan, but cannot obtain such financing as long as their loan remains in default. Thus the Fed’s proposal eliminates a homeowner’s ability to use their right of rescission as a creative form of refinancing, which has always been the practical purpose of this right.

The public comment period on the Fed’s proposal ended December 23, 2010 — as the Fed operates independent of any congressional body, homeowners struggling with foreclosure will simply have to wait and see if they may retain the most powerful weapon they currently have against foreclosure.

first tuesday take: With this proposal, the Fed makes a clear statement: the indefinite delay of home foreclosures makes for a weaker economy and a stagnant real estate market. Something must be done soon since congress is not taking sufficient action to cure the problem.

Whether it is robo-signers being reviewed or homeowners rattling their sabers, blame for the mortgage meltdown and ensuing foreclosure crisis will always be deflected to the next guy. The struggling homeowner will inevitably blame the bank for fraud; the foreclosing lender will argue the homeowner is not making their mortgage payment. This blame game will continue into perpetuity until someone takes either the cure of foreclosure (underwater homeowners) or the remedy of a principal reduction (mortgage lenders). [For more information on delayed foreclosures, see the October 2010 first tuesday article, BofA postpones organic economic recovery by halting foreclosures.]

Chances are the former will occur, whether now or later, despite months of doomed short sale negotiations and years of litigation. If anyone has forgotten the too-big-to fail argument of 2008, the recent second round of Quantitative Easing (QE2) serves as a potent reminder that lenders are still the keystone in the Fed’s designs for economic growth and stability. [For more information on the Fed’s efforts to bolster the economic recovery, see the October 2010 first tuesday article, Deflation’s push on the real estate recovery.]

However, this is not an example of the Fed taking sides, as the emotional outcries resound. The Fed’s decision to restrict the right of rescission is sound monetary logic that unfortunately takes the shape of a heated political argument, grounded in the tired old rhetoric of the American dream.

Given the limits of our current economic system, the Fed can only achieve so much via monetary policy. It is wise for the Fed to take politically sensitive action while they can to inject monetary sense into the arms of homeowners and lenders alike, whether they want the medicine or not.

Re: “Fed seeks to strip a key protection for homeowners” from the Sacramento Bee