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By Anne Flaherty
WASHINGTON (AP) — A House panel approved legislation Wednesday that would outlaw the kind of "liar loans" and other questionable bank practices that helped drag down the economy.

The proposal, by North Carolina Democratic Reps. Melvin Watt and Brad Miller, is one of several that Democrats are pushing to tighten financial regulations on an industry that underwrote risky loans and passed off the bad debt to investors.

While Democrats cast the bill as a necessary measure that could have helped prevent the financial meltdown, the banking industry and Republicans warned that the would-be rules could restrict the flow of credit.

"Now is not the time to limit choices, raise costs, disrupt the secondary mortgage market, and look the other way on fundamental ... reform" of government-created financial services corporations, said Rep. Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee.

Under the Democratic-pushed bill, banks offering other than traditional 30-year, fixed-rate mortgages would have to verify a person's credit history and income and make a "reasonable and good faith determination" that a loan can be repaid. This provision targets high-risk credit lines that became known as "liar loans" because they required little or no documentation.

Banks also would have to make sure the loan provides a "net tangible benefit" for the consumer.

Another provision would prohibit banks from paying mortgage brokers and loan officers more money if they steer clients toward more costly loan options. Under the bill, a broker would receive the same compensation for selling a 30-year, fixed-rate loan as he would a riskier adjustable-rate mortgage.

The legislation also would place new restrictions on banks wanting to sell nontraditional mortgages to Wall Street by requiring they retain at least some of the risk on their books. Proponents say doing so would further deter banks from lending to people with risky credit.

The panel's endorsement of the bill, by a 49-21 vote, paves the way for consideration by the full House next week.

Copyright 2009 The Associated Press.  All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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