NEW YORK (CNNMoney.com) -- Despite government calls for tougher regulation in the subprime mortgage market, brokers and lenders don't seem to be getting their guidance from Washington. Instead, they're turning to Wall Street.
It's not that mortgage originators are ignoring new Federal Reserve guidelines for subprime lending. It's just that they're guidelines -- not enforceable regulations. The situation is closer to "what-the-market-will-bear" -- or rather -- what it will put up with.
"It's more the market that's been dictating what kinds of loans are made. Lenders are reacting to what investors will buy," said Steve Habetz, a mortgage broker with Threshold Finance in Connecticut.
Mortgage loans are packaged by lenders and sold into secondary markets to hedge funds, pension funds and other investors.
Foreclosures dip but that won't last
So when regulators tightened subprime lending guidance in late June to try to curtail risky practices that led to record foreclosures - such as loans with little or no proof of earnings, loans with prepayment penalties and lax underwriting standards - all it did was reinforce a trend that Wall Street had started long before.
David Wyss, chief economist for Standard and Poor's, which rates the bonds backed by subprime and other mortgage loans, said Wall Street stopped buying the loans since early spring, long before the Fed released its guidelines.
"The market has been way ahead of the Fed," he said. "If anything, it has overreacted."
Doug Duncan, chief economist for the Mortgage Bankers Association, agreed with Wyss. "For more than six months there's been tightening," he said.
According to Duncan, three main practices have seen a marked change:
Equity - Borrowers have to put at least some money down in almost all cases and more money down in many cases. The 100 percent or no-down loan has become much rarer.
Stated income - Now you'll see few subprime loans without some proof of earnings.
Layered risk - Borrowers can still get by with a single ding on their credit profiles, such as spotty employment or low assets. But they won't be able to get away with two or three dings, as they did in the past.
According to George Hanzimanolis, president of the National Association of Mortgage Brokers, some lenders have even tightened beyond what the regulators have called for.
"They don't want to get stuck with loans when they try to sell them," he said.
Many brokers have found that they put together a deal using terms offered by lenders only to find that, weeks later, the lenders will no longer make the loan, usually because investors are no longer buying loans under those terms.
"That kind of trickle down happens quickly," said Hanzimanolis. "The whole market is pretty shaken. Some lenders will honor [their commitments]. Other times they'll just leave clients out in the cold."
That means fewer low-quality loans than just a few months ago.
"I am seeing tightening of standards," said Bob Moulton, a mortgage broker and founder of Americana Mortgage Group, "with much tougher underwriting."
Borrowers who would have qualified for a certain rate last year, now need considerably higher credit scores for the same loan today, he said.
Evidence that the market - not Washington -- is regulating subprime lending is that Moulton is still seeing prepayment penalties, which are fees due to retire a loan early.
The Fed wants lenders to stop the penalties. But ending them "is a problem for lenders giving away at teaser rates," said Moulton.
Lenders don't want to take a loss for two years at an initial low interest rate and then, just when they expect a loan to start paying off, have borrowers refinance out of them without paying a fee.
And no matter what the Fed says, if Wall Street is shopping for a product, "The loans will get to the table," said Moulton.
What may have hit lenders harder than the Fed, according to Allen Hardester, a mortgage broker in Columbia, Maryland, is when Standard and Poor's said it may lower its ratings on subprime-backed residential mortgage back securities last week (and had to correct its figures). That action rippled through the lending industry.
"It appears that the world is beginning to adjust dramatically," he said. "The downgrade had more impact than the guidelines."
Lower ratings on subprime bonds makes them more difficult to sell; lenders will stop writing them. The trouble is that brokers have already initiated many of these deals. But now they have no product.
"People are scrambling to find buyers for what's in the pipeline already," said Hardester. 
