The Federal Deposit Insurance Corp. issued guidelines last week to banks on precautions they can take to avoid investing in asset-backed securities that are backed by predatory loans, throwing itself into the heated predatory versus subprime lending debate.

"A way to break the money chain' that supports predatory loans is to be able to distinguish between securities backed by loans that are responsibly underwritten and priced and those that include loans with abusive or predatory features," said Donna Tanoue, chairwoman of the FDIC at a speech last month.

She cited the increasing amount of lawsuits filed by borrowers against originators to get their loans cancelled, as well as state and federal enforcement crackdown against lending companies could affect those loans that are placed into securities.

"To the extent that such suits involve loans that were pooled and sold to private investors, any legal requirement to refund or rescind loans could compromise such securities and hurt investors, including many banks that have invested in such mortgage-backed securities," Tanoue said.

The FDIC's guidelines, still open to public comment, address three areas that investors should take into account when considering purchasing mortgage-backed securities that might be backed by predatory loans.

The first is to know the issuer, and to check on the issuer's reputation, performance on other securities issued by the company and any ratings downgrades.

The second is to carefully review prospectuses, checking on various loan characteristics, including loan-to-value ratios and FICO scores, and whether the loans were made in compliance with various regulations such as HOEPA and RESPA.

Third, credit enhancement requirements should be reviewed, comparing the particular security's credit enhancement to other subprime securitizations in terms of collateral, subordinated securities, bond insurance and interest-only securities.

While the FDIC's goal is to "assist banks in protecting themselves from legal and reputational risks posed by association with predatory loans," said Tanoue, some market sources believe these guidelines could cause more banks to exit the subprime mortgage market.

"These guidelines direct once removed investor banks to make the distinction between subprime and predatory," said an observer familiar with the guidelines. "A determination that cannot be made. This part was written by somebody with no practical experience, it will be enforced by people with even less practical experience and will have the effect of driving banks out of the subprime home-equity ABS market."

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