Federal regulators and mortgage lenders were largely responsible for a housing and mortgage crisis that's likely to worsen, according to a white paper submitted to the Federal Reserve by Weiss Research, Inc., an investment research firm.

Rather than act as a moderating force, the Federal Reserve played an important role in further inflating the housing bubble that's at the root of the current crisis. Rather than accept a decline in lending volume as homes became less affordable, lenders debased their standards and incurred the risk of serious long-term damage to their finances, the industry, and, ultimately, the economy. Wall Street's large-scale transformation of mortgages into securities significantly boosted risk-taking.

"For many Americans, the dream of home ownership is turning into a nightmare," writes Larson. "And although borrowers must also share a part of the blame, the burden falls on regulators and lenders to take firm steps to remedy their errors."

It is often believed that loan losses and defaults have been limited to companies specializing in higher-risk, or subprime mortgages. Larson takes issue with that notion, naming 63 traditional banks and thrifts that may be especially vulnerable to the crisis, based on high ratios of nonperforming mortgage loans. "Loan delinquencies and foreclosures are rising throughout the mortgage system, and the mortgage crisis is not limited to niche players that specialized in low-quality loans," says Larson.

With the goal of avoiding quick fixes and fostering a healthy, long-term recovery, Weiss Research offers the following proposals to federal regulators and legislators:

1. Closer monitoring and prompter action by the Federal Reserve to help avert run-away asset price inflation.

2. Better enforcement of existing predatory lending statutes.

3. Better protection of borrowers through a model akin to one recently established between the Office of Thrift Supervision (OTS) and three subsidiaries of American International Group.

4. Greater focus by regulators on banks and thrifts whose mortgage performance measures are showing the most stress.

5. Suitability requirements for the mortgage lending industry.

6. Rather than a ban on special-purpose mortgages, procedures to limit them to the uniquely qualified borrowers for which they were originally designed.

7. Federal training, education, licensing, and testing standards for mortgage lenders.

8. Assignee liability for secondary market buyers of home loans.

9. More focus on developing programs that promote saving for a down payment.

Larson concludes: "These solutions cannot be painless. But in order to pave the way for a sounder future, many of the sacrifices that were avoided in the past may have to be made in the present."