Journalist @baltimoresun writer artist runner #amwriting Chaplain PIO #partylikeajournalist

Journalist @baltimoresun writer artist runner #amwriting Chaplain PIO #partylikeajournalist
Journalist @baltimoresun writer artist runner #amwriting Md Troopers Assoc #20 & Westminster Md Fire Dept Chaplain PIO #partylikeajournalist
Showing posts with label People Bernanke-Ben. Show all posts
Showing posts with label People Bernanke-Ben. Show all posts

Friday, October 24, 2008

My three part series on the current economic mess in The Tentacle


My three part series on the current economic mess in The Tentacle


Folks have been asking where they can find my three-part series on the current economic mess in The Tentacle from October 1, 2 and 3, 2008.

They may be found here:

October 3, 2008
Congress and The Rattlesnake – Part 3
Kevin E. Dayhoff
On May 13, 2008, Democratic presidential nominee Barack Obama compared the current housing crisis in the U.S. to the Great Depression in a campaign stop in Missouri.


October 2, 2008
Congress and The Rattlesnake – Part 2
Kevin E. Dayhoff
For several weeks the nation and the world have been watching the financial news emanating from Washington and Wall Street with that “deer in headlights” look as everyone holds their breath in disbelief and worries another shoe will drop.


October 1, 2008
Congress and the Rattlesnake – Part 1
Kevin E. Dayhoff
In response to the increasing wrath of the American voter, the U.S. House of Representatives came to its senses on Monday and voted 288 to 205 to kill the rash and ill-conceived proposed $700 billion bailout of Wall Street.

20081003 My three part series on the current economic mess in The Tentacle

Friday, October 10, 2008

Chairman Ben S. Bernanke At the National Association for Business Economics 50th Annual Meeting, Washington, D.C.

Chairman Ben S. Bernanke At the National Association for Business Economics 50th Annual Meeting, Washington, D.C.

Related: Speech - Chairman Ben S. Bernanke At the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, Illinois

October 7, 2008

Current Economic and Financial Conditions

http://www.federalreserve.gov/newsevents/speech/bernanke20081007a.htm

Good afternoon. I am pleased to have once again the opportunity to address the National Association for Business Economics. My remarks today will focus on recent developments in the financial sector and the economy and on the challenges we face.

As you know, financial systems in the United States and in much of the rest of the world are under extraordinary stress, particularly the credit and money markets. The losses suffered by many banks and nonbank financial firms have both constrained their ability to lend and reduced the willingness of other market participants to deal with them. Great uncertainty about the values of financial assets, particularly more complex and opaque assets, has made investors extremely reluctant to bear credit risk, resulting in further declines in asset prices and a drying up of liquidity in a number of funding markets. Even secured funding has become expensive and difficult to obtain, as lenders worry about their ability to sell collateral in illiquid markets in the event of default. In addition, many securitization markets, such as the secondary market for private-label mortgage-backed securities, remain closed or impaired.

Considerable experience in both industrialized and emerging economies has shown that severe financial instability, together with the associated declines in asset prices and disruptions in credit markets, can take a heavy toll on the broader economy if left unchecked. For this reason, the Federal Reserve, the Treasury, and other agencies are committed to restoring market stability and are working assiduously to ensure that the financial system is able to perform its critical economic functions. Recent actions by the Congress have given the Treasury new tools and resources to address the stressed conditions of our financial markets and institutions. The Federal Reserve has also been granted a new authority, the ability to pay interest on bank reserves, which will allow us to expand our lending as needed to support the system while better managing the federal funds rate. These tools will provide important additional support for the government's efforts to strengthen financial markets and the economy.

Let me briefly review recent financial developments. On the heels of nearly a year of stress in credit markets, investors' and creditors' concerns about funding and credit risks at financial firms intensified over the summer as mortgage-related assets deteriorated further, economic growth slowed, and uncertainty about the economic outlook increased. As investors and creditors lost confidence in the ability of certain firms to meet their obligations, their access to capital markets as well as to short-term funding markets became increasingly impaired and their stock prices fell sharply. Among the companies that experienced this dynamic most forcefully were the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac; the investment bank Lehman Brothers; and the insurance company American International Group (AIG).

The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector arrangements--for example, by raising new equity capital, as many firms have done, by negotiations leading to a merger or acquisition, or by an orderly wind-down. Government assistance should be provided with the greatest reluctance and only when the stability of the financial system, and thus the health of the broader economy, is at risk. In those cases when financial stability is threatened, however, intervention to protect the public interest may well be justified.

Fannie Mae and Freddie Mac present cases in point. The Federal Reserve had long warned about the systemic risks posed by these companies' large portfolios of mortgages and mortgage-backed securities, as well as the problems arising from the conflict between shareholders' objectives and the government's goals for the two firms. Given the scale of losses in their portfolios, raising enough new capital from private investors was infeasible. The firms' size and their government-sponsored status precluded a merger with, or acquisition by, another company. To avoid unacceptably large dislocations in the mortgage markets, the financial sector, and the economy as a whole, the Federal Housing Finance Agency (FHFA) put Fannie and Freddie into conservatorship and the Treasury, drawing on authorities recently granted by the Congress, made financial support available. The Federal Reserve, acting in a consultative role, worked closely with FHFA in evaluating the GSE portfolios and capital positions. Based on the joint findings of the agencies, we supported FHFA's decision to place the companies into conservatorship as necessary and appropriate, given their conditions and systemic importance. The government's actions appear to have stabilized the GSEs, although like virtually all other firms they are experiencing effects of the current crisis. Nonetheless, we already have seen benefits of their stabilization in the form of lower mortgage rates, which should help the housing market.

The difficulties at Lehman and AIG raised somewhat different issues. Like the GSEs, both companies were large and complex and deeply embedded in our financial system. In both cases, as the firms approached default, the Treasury and the Federal Reserve sought private-sector solutions, but none was forthcoming. Attempts to organize a consortium of private firms to purchase or recapitalize Lehman were unsuccessful. With respect to public-sector solutions, we determined that either facilitating a sale of Lehman or maintaining the company as a free-standing entity would have required a very sizable injection of public funds--much larger than in the case of Bear Stearns--and would have involved the assumption by taxpayers of billions of dollars of expected losses. Even if assuming these costs could be justified on public policy grounds, neither the Treasury nor the Federal Reserve had the authority to commit public money in that way; in particular, the Federal Reserve's loans must be sufficiently secured to provide reasonable assurance that the loan will be fully repaid. Such collateral was not available in this case. Recognizing that Lehman's potential failure posed risks to market functioning, the Federal Reserve sought to cushion the effects by implementing a number of measures, including substantially broadening the collateral accepted by the Fed's Primary Dealer Credit Facility (PDCF) and Term Securities Lending Facility (TSLF) to ensure that the remaining primary dealers would have uninterrupted access to funding.

In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure of AIG would have severely threatened global financial stability and the performance of the U.S. economy. That judgment reflected our assessment of prevailing market conditions, AIG's central role in a number of markets other firms use to manage risks, and the size and composition of AIG's balance sheet. To avoid the default of AIG, the Federal Reserve was able to provide emergency credit that was judged to be adequately secured by the assets of the company. To protect U.S. taxpayers and to mitigate the possibility that lending to AIG would encourage inappropriate risk-taking by financial firms in the future, the Federal Reserve further ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm's owners, managers, and creditors.

AIG's difficulties and Lehman's failure, along with growing concerns about the U.S. housing sector and economy, contributed to extraordinarily turbulent conditions in global financial markets in recent weeks. Equity prices have fallen sharply, the cost of short-term credit, where such credit has been available, has spiked, and liquidity has dried up in many markets. One money market fund's losses forced it to "break the buck"--that is, the value of its assets fell below par--an event that triggered extensive withdrawals from a number of money market funds. Those funds responded to the surge in redemptions by attempting to reduce their holdings of commercial paper and large certificates of deposit issued by banks. Some firms that could not roll over maturing commercial paper drew on back-up lines of credit with banks just as the banks were finding it even more difficult to raise cash in the money markets. At the same time, a marked increase in the demand for safe assets--a flight to quality and liquidity--resulted in a further drop in the value of mortgage-related assets and sent the yield on Treasury bills down to a few hundredths of a percent.

Developments during the summer pressured not only nonbank financial firms, but also a number of depository institutions, including Washington Mutual (WaMu) and Wachovia. In recent weeks, these two institutions suffered deposit outflows and reduced access to wholesale funding. The Office of Thrift Supervision, WaMu's regulator, closed that company and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver; the FDIC immediately sold the institution to JPMorgan Chase. In the case of Wachovia, to avoid serious adverse effects on economic conditions and financial stability, the Secretary of the Treasury, in consultation with the President and on the recommendation of the Federal Reserve and FDIC, authorized the FDIC to use its funds to facilitate the sale of that company's banking operations without loss to creditors. Both Citicorp and Wells Fargo have offered to buy the company and negotiations are continuing. Most importantly, however, in either case all depositors and creditors of Wachovia are fully protected, and depositors and other customers will experience no interruption in banking services.

By potentially restricting future flows of credit to households and businesses, the developments in financial markets pose a significant threat to economic growth. The Treasury and the Fed have taken a range of actions to address the very tight funding conditions that now prevail. For example, the Treasury implemented a temporary guarantee program for balances held in money market mutual funds, helping to stem the outflows from these funds and thus reducing their need to sell assets into already distressed markets. The Federal Reserve has taken a number of steps, including putting in place a temporary lending facility that provides financing for banks to purchase high-quality asset-backed commercial paper from money market funds. The Fed has also significantly increased the quantity of funds it auctions to banks and has accommodated heightened demands for funding from banks and primary dealers; as of last Wednesday, our various lending facilities, including our securities lending program, were providing more than $800 billion of liquidity to the financial system. To address dollar funding pressures worldwide, we have significantly expanded reciprocal currency arrangements (so-called swap agreements) with foreign central banks. These agreements enable the foreign central banks to provide dollar funding to financial institutions in their jurisdictions, which helps to improve the functioning of dollar funding markets globally. In addition, this morning the Federal Reserve announced a new facility that will help provide liquidity to term funding markets by purchasing three-month commercial paper and asset-backed commercial paper directly from eligible issuers.

The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding. Recently, however, our liquidity provision had begun to run ahead of our ability to absorb excess reserves held by the banking system, leading the effective funds rate, on many days, to fall below the target set by the Federal Open Market Committee. This problem has largely been addressed by a provision of the legislation the Congress passed last week, which gives the Federal Reserve the authority to pay interest on balances that depository institutions hold in their accounts at the Federal Reserve Banks. The Federal Reserve announced yesterday that it will pay interest on required reserve balances at 10 basis points below the target federal funds rate, and pay interest on excess reserves, initially at 75 basis points below the target. Paying interest on reserves should allow us to better control the federal funds rate, as banks are unlikely to lend overnight balances at a rate lower than they can receive from the Fed; thus, the payment of interest on reserves should set a floor for the funds rate over the day. With this step, our lending facilities may be more easily expanded as necessary. So long as financial conditions warrant, we will continue to look for ways to reduce funding pressures in key markets.

Economic activity had shown signs of decelerating even before the recent upsurge in financial-market tensions. As has been the case for some time, the housing market continues to be a primary source of weakness in the real economy as well as in the financial markets. However, the slowdown in economic activity has spread outside the housing sector. Private payrolls have continued to contract, and the declines in employment, together with earlier increases in food and energy prices, have eroded the purchasing power of households. This sluggishness of real incomes, together with tighter credit and declining household wealth, is now showing through more clearly to consumer spending. Indeed, since May, real consumer outlays have contracted significantly. Meanwhile, in the business sector, worsening sales prospects and a heightened sense of uncertainty have begun to weigh more heavily on investment spending as well.

The intensification of financial turmoil and the further impairment of the functioning of credit markets seem likely to increase the restraint on economic activity in the period ahead. Even households with good credit histories are now facing difficulties obtaining mortgage loans or home equity lines of credit. Banks are also reducing credit card limits, and denial rates on automobile loan applications reportedly are rising. Businesses, too, are confronting diminished access to credit. For example, disruptions in the commercial paper market and tightening of bank lending standards have made it more difficult for businesses to obtain the working capital they need to meet everyday operating expenses such as payrolls and inventories.

All told, economic activity is likely to be subdued during the remainder of this year and into next year. The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth. To support growth and reduce the downside risks, continued efforts to stabilize the financial markets are essential. The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.

Inflation has been elevated, reflecting the steep increases in the prices of oil, other commodities, and imports that occurred earlier this year, as well as some pass-through by firms to consumers of their higher costs of production. However, more recently, the prices of oil and other commodities, while remaining quite volatile, have fallen from their peaks, and prices of imports show signs of decelerating. In addition, expected inflation, as measured by consumer surveys and inflation-indexed Treasury securities, has held steady or eased. These recent developments, together with economic activity that is likely to fall short of potential for a time, should lead to rates of inflation more consistent with price stability. Still, the inflation outlook remains highly uncertain, in part because of the extraordinary volatility of commodity prices. We will need to continue to monitor price developments closely.

Overall, the combination of the incoming data and recent financial developments suggests that the outlook for economic growth has worsened and that the downside risks to growth have increased. At the same time, the outlook for inflation has improved somewhat, though it remains uncertain. In light of these developments, the Federal Reserve will need to consider whether the current stance of policy remains appropriate.

The intensification of the financial crisis in recent weeks made clear that a more powerful and comprehensive approach involving the fiscal authorities was needed to solve these problems. On that basis, the Secretary of the Treasury, with the support of the Federal Reserve, went to the Congress to ask for a substantial program aimed at stabilizing our financial markets. As you know, last week the Congress passed and the President signed the Emergency Economic Stabilization Act. This legislation provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy. The act adds broad, flexible authorities to buy troubled assets, to provide guarantees, and to directly strengthen the balance sheets of individual institutions. Notably, the legislation establishes a new Troubled Asset Relief Program, or TARP, under which the Treasury is authorized to purchase as much as $700billion of troubled mortgages, mortgage-related securities, and other financial instruments from financial firms that are regulated under U.S. law and have significant operations in the United States. The act also raises the limit on deposit insurance at banks and credit unions from $100,000 to $250,000 per account, a step that should reinforce depositors' confidence in the security of their funds and thus help to stabilize depository institutions. And, as I mentioned, the act provides the Federal Reserve the authority to pay interest on reserves, which will allow us to better manage the federal funds rate as we provide liquidity to the markets. We will begin exercising that authority this week.

The TARP's purchases of illiquid assets from banks and other financial institutions will create liquidity and promote price discovery in the markets for these assets. This in turn will reduce investor uncertainty about the current value and prospects of financial institutions, enabling banks and other institutions to raise capital and increasing the willingness of counterparties to engage. More generally, increased liquidity and transparency in pricing will help to restore confidence in our financial markets and promote more normal functioning. With time, strengthening our financial institutions and markets will allow credit to begin flowing again, supporting economic growth.

The interests of taxpayers are carefully protected under this program. First, the Congress has required extensive controls and oversight to ensure that the allotted funds are used appropriately and effectively. Second, the $700 billion allocated by the legislation is not an authorization to spend but rather an authorization to purchase financial assets. The Treasury will be a patient investor and will likely hold these assets for an appreciable period of time. Eventually, however, some assets will mature, and the Treasury will choose to sell others to private investors. Financially, in the long run, the taxpayer may come out either ahead or behind in this process; in light of the many uncertainties, no assurances can be given. But the ultimate cost of the program to the taxpayer will certainly be far less than $700 billion. Third, and most important, restoring the normal flow of credit is essential for economic recovery. If the TARP promotes financial stability, leading ultimately to stronger economic growth and job creation, it will have proved a very good investment indeed, to everyone's benefit.

To be sure, there are many challenges associated with the design and implementation of the TARP, including determining which assets will be purchased and how prices will be determined. The Treasury, with the advice and cooperation of the Federal Reserve, is working to address these challenges as quickly as possible. It is unlikely that a single method will be used for acquiring assets; inevitably, some experimentation will be necessary to determine which approaches are most effective. Importantly, the legislation that created the TARP does provide sufficient flexibility to allow for different approaches to solving the problem--subject, of course, to the close oversight that will ensure that the program's funds are used in ways that are in the interest of taxpayers.

These are momentous steps, but they are being taken to address a problem of historic dimensions. In one respect, however, we are fortunate. We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today. The Congress and the Administration chose to act at a moment of great stress, but one at which the great majority of financial institutions have sufficient capital and liquidity to return to their critical function of providing new credit for our economy. The steps being taken now to restore confidence in our institutions and markets will go far to resolving the current dislocations in the markets. I believe that the bold actions taken by the Congress, the Treasury, the Federal Reserve, and other agencies, together with the natural recuperative powers of the financial markets, will lay the groundwork for financial and economic recovery.

Sunday, September 21, 2008

Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments


Statement by Secretary Henry M. Paulson, Jr. on Comprehensive Approach to Market Developments

From the
Press Room of the U.S. Department of the Treasury

September 19, 2008

Washington, DC-- Last night, Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox and I had a lengthy and productive working session with Congressional leaders. We began a substantive discussion on the need for a comprehensive approach to relieving the stresses on our financial institutions and markets.

We have acted on a case-by-case basis in recent weeks, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner. And this morning we've taken a number of powerful tactical steps to increase confidence in the system, including the establishment of a temporary guaranty program for the U.S. money market mutual fund industry.

Despite these steps, more is needed. We must now take further, decisive action to fundamentally and comprehensively address the root cause of our financial system's stresses.

The underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy. When the financial system works as it should, money and capital flow to and from households and businesses to pay for home loans, school loans and investments that create jobs. As illiquid mortgage assets block the system, the clogging of our financial markets has the potential to have significant effects on our financial system and our economy.

As we all know, lax lending practices earlier this decade led to irresponsible lending and irresponsible borrowing. This simply put too many families into mortgages they could not afford. We are seeing the impact on homeowners and neighborhoods, with 5 million homeowners now delinquent or in foreclosure. What began as a sub-prime lending problem has spread to other, less-risky mortgages, and contributed to excess home inventories that have pushed down home prices for responsible homeowners.

A similar scenario is playing out among the lenders who made those mortgages, the securitizers who bought, repackaged and resold them, and the investors who bought them. These troubled loans are now parked, or frozen, on the balance sheets of banks and other financial institutions, preventing them from financing productive loans. The inability to determine their worth has fostered uncertainty about mortgage assets, and even about the financial condition of the institutions that own them. The normal buying and selling of nearly all types of mortgage assets has become challenged.

These illiquid assets are clogging up our financial system, and undermining the strength of our otherwise sound financial institutions. As a result, Americans' personal savings are threatened, and the ability of consumers and businesses to borrow and finance spending, investment, and job creation has been disrupted.

To restore confidence in our markets and our financial institutions, so they can fuel continued growth and prosperity, we must address the underlying problem.

The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.

I believe many Members of Congress share my conviction. I will spend the weekend working with members of Congress of both parties to examine approaches to alleviate the pressure of these bad loans on our system, so credit can flow once again to American consumers and companies. Our economic health requires that we work together for prompt, bipartisan action.
As we work with the Congress to pass this legislation over the next week, other immediate actions will provide relief.

First, to provide critical additional funding to our mortgage markets, the GSEs Fannie Mae and Freddie Mac will increase their purchases of mortgage-backed securities (MBS). These two enterprises must carry out their mission to support the mortgage market.

Second, to increase the availability of capital for new home loans, Treasury will expand the MBS purchase program we announced earlier this month. This will complement the capital provided by the GSEs and will help facilitate mortgage availability and affordability.

These two steps will provide some initial support to mortgage assets, but they are not enough. Many of the illiquid assets clogging our system today do not meet the regulatory requirements to be eligible for purchase by the GSEs or by the Treasury program.

I look forward to working with Congress to pass necessary legislation to remove these troubled assets from our financial system. When we get through this difficult period, which we will, our next task must be to improve the financial regulatory structure so that these past excesses do not recur. This crisis demonstrates in vivid terms that our financial regulatory structure is sub-optimal, duplicative and outdated. I have put forward my ideas for a modernized financial oversight structure that matches our modern economy, and more closely links the regulatory structure to the reasons why we regulate. That is a critical debate for another day.

Right now, our focus is restoring the strength of our financial system so it can again finance economic growth. The financial security of all Americans – their retirement savings, their home values, their ability to borrow for college, and the opportunities for more and higher-paying jobs – depends on our ability to restore our financial institutions to a sound footing.

20080919 Sec Paulson st on Comprehensive Approach to Mrkt Dev

Federal Reserve Chairman Ben Bernanke, SEC Chairman Chris Cox, U.S. Department of the Treasury Secretary Henry M. Paulson, Jr.

People Bernanke-Ben, Business Econ Wall St SEC, People Cox-Chris, US Dept Treasury, People Paulson-Henry, Bus Econ Subprime Mortgage Market Crisis

Business Econ Wall St SEC Cox qv People, Business Econ Bernanke-B qv People, Business Econ US Dept Treasury qv US, Business Econ Paulson qv People, Subprime Mortgage Mrkt Crisis qv Bus, 2007 2008 Subprime Mort Crisis qv Bus

Saturday, May 19, 2007

Speech - Chairman Ben S. Bernanke At the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, Illinois

Speech - Chairman Ben S. Bernanke At the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, Illinois

May 17, 2007

The Subprime Mortgage Market

http://www.federalreserve.gov/newsevents/speech/bernanke20070517a.htm

The recent sharp increases in subprime mortgage loan delinquencies and in the number of homes entering foreclosure raise important economic, social, and regulatory issues. Today I will address a series of questions related to these developments. Why have delinquencies and initiations of foreclosure proceedings risen so sharply? How have subprime mortgage markets adjusted? How have Federal Reserve and other policymakers responded, and what additional actions might be considered? How might the problems in the market for subprime mortgages affect housing markets and the economy more broadly?

The Development of the Subprime Mortgage Market
Let me begin with some background. Subprime mortgages are loans made to borrowers who are perceived to have high credit risk, often because they lack a strong credit history or have other characteristics that are associated with high probabilities of default. Having emerged more than two decades ago, subprime mortgage lending began to expand in earnest in the mid-1990s, the expansion spurred in large part by innovations that reduced the costs for lenders of assessing and pricing risks. In particular, technological advances facilitated credit scoring by making it easier for lenders to collect and disseminate information on the creditworthiness of prospective borrowers. In addition, lenders developed new techniques for using this information to determine underwriting standards, set interest rates, and manage their risks.

The ongoing growth and development of the secondary mortgage market has reinforced the effect of these innovations. Whereas once most lenders held mortgages on their books until the loans were repaid, regulatory changes and other developments have permitted lenders to more easily sell mortgages to financial intermediaries, who in turn pool mortgages and sell the cash flows as structured securities. These securities typically offer various risk profiles and durations to meet the investment strategies of a wide range of investors. The growth of the secondary market has thus given mortgage lenders greater access to the capital markets, lowered transaction costs, and spread risk more broadly, thereby increasing the supply of mortgage credit to all types of households.

These factors laid the groundwork for an expansion of higher-risk mortgage lending over the past fifteen years or so. Growth in the market has not proceeded at a uniform pace, but on net it has been dramatic. About 7-1/2 million first-lien subprime mortgages are now outstanding, accounting for about 14 percent of all first-lien mortgages.1 So-called near-prime loans--loans to borrowers who typically have higher credit scores than subprime borrowers but whose applications may have other higher-risk aspects--account for an additional 8 to 10 percent of mortgages.2

The expansion of subprime mortgage lending has made homeownership possible for households that in the past might not have qualified for a mortgage and has thereby contributed to the rise in the homeownership rate since the mid-1990s. In 2006, 69 percent of households owned their homes; in 1995, 65 percent did. The increase in homeownership has been broadly based, but minority households and households in lower-income census tracts have recorded some of the largest gains in percentage terms. Not only the new homeowners but also their communities have benefited from these trends. Studies point to various ways in which homeownership helps strengthen neighborhoods. For example, homeowners are more likely than renters to maintain their properties and to participate in civic organizations. Homeownership has also helped many families build wealth, and accumulated home equity may serve as a financial reserve that can be tapped as needed at a lower cost than most other forms of credit.

Broader access to mortgage credit is not without its downside, however. Not surprisingly, in light of their weaker credit histories and financial conditions, subprime borrowers face higher costs of borrowing than prime borrowers do and are more likely to default than prime borrowers are. For borrowers, the consequences of defaulting can be severe--possibly including foreclosure, the loss of accumulated home equity, and reduced access to credit. Their neighbors may suffer as well, as geographically concentrated foreclosures tend to reduce property values in the surrounding area.

The Recent Problems in the Subprime Mortgage Sector
With this background in mind, I turn now to the recent problems in the subprime mortgage sector. In general, mortgage credit quality has been very solid in recent years. However, that statement is no longer true of subprime mortgages with adjustable interest rates, which currently account for about two-thirds of subprime first-lien mortgages or about 9 percent of all first-lien mortgages outstanding. For these mortgages, the rate of serious delinquencies--corresponding to mortgages in foreclosure or with payments ninety days or more overdue--rose sharply during 2006 and recently stood at about 11 percent, about double the recent low seen in mid-2005.34 Subprime mortgages accounted for more than half of the foreclosures started in the fourth quarter. The rate of serious delinquencies has also risen somewhat among some types of near-prime mortgages, although the rate in that category remains much lower than the rate in the subprime market. The rise in delinquencies has begun to show through to foreclosures. In the fourth quarter of 2006, about 310,000 foreclosure proceedings were initiated, whereas for the preceding two years the quarterly average was roughly 230,000.

The sharp rise in serious delinquencies among subprime adjustable-rate mortgages (ARMs) has multiple causes. "Seasoned" mortgages--mortgages that borrowers have paid on for several years--tend to have higher delinquency rates. That fact, together with the moderation in economic growth, would have been expected to produce some deterioration in credit quality from the exceptionally strong levels seen a few years ago. But other factors, too, have been at work. After rising at an annual rate of nearly 9 percent from 2000 through 2005, house prices have decelerated, even falling in some markets. At the same time, interest rates on both fixed- and adjustable-rate mortgage loans moved upward, reaching multi-year highs in mid-2006. Some subprime borrowers with ARMs, who may have counted on refinancing before their payments rose, may not have had enough home equity to qualify for a new loan given the sluggishness in house prices. In addition, some owners with little equity may have walked away from their properties, especially owner-investors who do not occupy the home and thus have little attachment to it beyond purely financial considerations. Regional economic problems have played a role as well; for example, some of the states with the highest delinquency and foreclosure rates are among those most hard-hit by job cuts in the auto industry.

The practices of some mortgage originators have also contributed to the problems in the subprime sector. As the underlying pace of mortgage originations began to slow, but with investor demand for securities with high yields still strong, some lenders evidently loosened underwriting standards. So-called risk-layering--combining weak borrower credit histories with other risk factors, such as incomplete income documentation or very high cumulative loan-to-value ratios--became more common. These looser standards were likely an important source of the pronounced rise in "early payment defaults"--defaults occurring within a few months of origination--among subprime ARMs, especially those originated in 2006.

Although the development of the secondary market has had great benefits for mortgage-market participants, as I noted earlier, in this episode the practice of selling mortgages to investors may have contributed to the weakening of underwriting standards. Depending on the terms of the sale, when an originator sells a loan and its servicing rights, the risks (including, of course, any risks associated with poor underwriting) are largely passed on to the investors rather than being borne primarily by the company that originated the loan. In addition, incentive structures that tied originator revenue to the number of loans closed made increasing loan volume, rather than ensuring quality, the objective of some lenders. Investors normally have the right to put early-payment-default loans back to the originator, and one might expect such provisions to exert some discipline on the underwriting process. However, in the most recent episode, some originators had little capital at stake and did not meet their buy-back obligations after the sharp rise in delinquencies.5 Intense competition for subprime mortgage business--in part the result of the excess capacity in the lending industry left over from the refinancing boom earlier in the decade--may also have led to a weakening of standards. In sum, some misalignment of incentives, together with a highly competitive lending environment and, perhaps, the fact that industry experience with subprime mortgage lending is relatively short, likely compromised the quality of underwriting.

The accuracy of much of the information on which the underwriting was based is also open to question. Mortgage applications with little documentation were vulnerable to misrepresentation or overestimation of repayment capacity by both lenders and borrowers, perhaps with the expectation that rising house prices would come to the rescue of otherwise unsound loans. Some borrowers may have been misled about the feasibility of paying back their mortgages, and others may simply have not understood the sometimes complex terms of the contracts they signed.

As the problems in the subprime mortgage market have become manifest, we have seen some signs of self-correction in the market. Investors are scrutinizing subprime loans more carefully and, in turn, lenders have tightened underwriting standards. Credit spreads on new subprime securitizations have risen, and the volume of mortgage-backed securities issued indicates that subprime originations have slowed. But although the supply of credit to this market has been reduced--and probably appropriately so--credit has by no means evaporated. For example, even as purchases of securitized subprime mortgages for collateralized debt obligations--an important source of demand--have declined, increased purchases by investment banks, hedge funds, and other private pools of capital are beginning to fill the void. Some subprime originators have gone out of business as their lenders have cancelled credit lines, but others have been purchased by large financial institutions and remain in operation. Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits.

What about borrowers already in distress? The Board and other federal supervisory agencies have taken actions to encourage the banks and thrift institutions we supervise to work with borrowers who may be having trouble meeting their mortgage obligations. Often, loan workouts are in the interest of both parties. With effective loan restructuring, borrowers facing temporary economic setbacks may be able to work through their problems while staying in their homes, and lenders may be able to avoid the costs of foreclosure and the losses usually associated with selling a repossessed home.

Servicers of loans aim to minimize losses, and they appear to be actively working with thousands of individual borrowers to modify their mortgages. To some extent, the dispersed ownership of mortgages may combine with legal and accounting rules to make successful workouts more difficult to achieve. For example, the "pooling and servicing agreement" associated with a given securitized mortgage pool may restrict the share of accounts that can be modified. Accounting rules that, in some cases, require substantially modified pools to be brought back on the originator’s balance sheet may dissuade lenders from undertaking workouts. And extensive modifications that reallocate expected cash flows across different securities associated with the pool could trigger a review of those securities by the ratings agencies. At the same time, if workouts are economically viable, then an incentive exists for third parties to purchase distressed pools at a discount and to undertake the workout process. We see these purchases taking place in the marketplace, a development that should help to increase the number of successful workouts.

Also, local community organizations that work to promote homeownership and prevent foreclosures have stepped up their efforts. For example, NeighborWorks America advises borrowers about restructuring their mortgages. A survey conducted by this group found that many homeowners do not understand that lenders also want to avoid foreclosure. Thus, the simple step of encouraging borrowers in trouble to contact their lenders can be very productive. The Federal Reserve and the other supervisory agencies have encouraged financial institutions to identify and contact borrowers who, with counseling and financial assistance, may be able to avoid entering delinquency or foreclosure. Indeed, some lenders are being proactive in this regard--for example, by contacting borrowers to discuss possible options well before a scheduled interest-rate reset.

Possible Regulatory Responses
Looking forward, the Federal Reserve, other regulators, and the Congress must evaluate what we have learned from the recent episode and decide what additional regulation or oversight may be needed to prevent a recurrence. In deciding what actions to take, regulators must walk a fine line; we must do what we can to prevent abuses or bad practices, but at the same time we do not want to curtail responsible subprime lending or close off refinancing options that would be beneficial to borrowers.

Broadly speaking, financial regulators have four types of tools to protect consumers and to promote safe and sound underwriting practices. First, they can require disclosures by lenders that help consumers make informed choices. Second, they can prohibit clearly abusive practices through appropriate rules. Third, they can offer principles-based guidance combined with supervisory oversight. Finally, regulators can take less formal steps, such as working with industry participants to establish and encourage best practices or supporting counseling and financial education for potential borrowers.

In the area of disclosure, the Federal Reserve is responsible for writing the regulation that implements the Truth in Lending Act (TILA), known as Regulation Z. The purpose of Regulation Z is to ensure that lenders provide borrowers or potential borrowers with clear, accurate, and timely information about the terms and conditions of loans. The Federal Reserve is also authorized to write rules; notably, the Home Ownership Equity Protection Act (HOEPA) gives the Board the power to prohibit acts and practices in mortgage lending deemed "unfair" or "deceptive."6 Both the disclosures required by TILA and the rules developed under HOEPA (which is part of TILA) apply to all lenders, not just banks. In cooperation with the other federal banking regulators, the Board can also draft supervisory guidance and back it up with regular examinations. Supervisory guidance applies only to banks and thrift institutions, although state regulators of nonbank lenders can and sometimes do adopt guidance written by the federal regulators.

In my judgment, effective disclosures should be the first line of defense against improper lending. If consumers are well informed, they are in a much better position to make decisions in their own best interest. However, combating bad lending practices, including deliberate fraud or abuse, may require additional measures. Rules are useful if they can be drawn sharply, with bright lines, and address practices that are never, or almost never, legitimate. Sometimes, however, specific lending practices that may be viewed as inappropriate in some circumstances are appropriate in others, and the conditions under which those practices are appropriate cannot be sharply delineated in advance. In such cases, supervisory guidance that establishes principles or guidelines is, when applicable, probably the better approach. Guidance can be modified as needed to apply to different situations, and thus can be a more flexible tool than rules for accomplishing regulators’ goals.

As I noted, markets are adjusting to the problems in the subprime market, but the regulatory agencies must consider what additional steps might be needed. The Federal Reserve is currently undertaking a thorough review of all its options under the law. Under its TILA authority, the Board last summer began a top-to-bottom evaluation of mortgage-related disclosures with a series of four open hearings around the country, in which we heard public concerns about various mortgage-related issues, including predatory lending and the effectiveness of the currently required disclosures. Using consumer testing, we will be working to improve the disclosures associated with mortgage lending and to fight deceptive marketing practices. This effort will draw heavily on our nearly-completed review of disclosures relating to open-end credit, including credit cards, for which we made extensive use of consumer testing to determine which disclosure formats are most effective and informative.7

Of course, the information provided by even the best-designed disclosures can be useful only when it is well understood. Accordingly, the Federal Reserve produces and regularly updates a range of materials, including a booklet that lenders are required to provide to potential ARM borrowers, to help consumers understand ARMs and other alternative mortgages; and we will continue to promote financial education through a variety of partnerships with outside organizations. Federal Reserve Banks around the country will also continue their cooperation with educational and community organizations that provide counseling about mortgage products and the responsibilities of homeownership.

We are also actively reviewing the possible use of our rule-making authority to prohibit certain specific practices. In 2001, the Board acted under its HOEPA authority to ban several practices for high-cost loans that were determined to be unfair or deceptive, such as loan flipping--frequent and repeated refinancing to generate fees for lenders. The Board will consider whether other lending practices meet the legal definition of unfair and deceptive and thus should be prohibited under HOEPA. Any new rules that we issue should be sharply drawn, however. As lenders are subject not only to regulatory enforcement action but possibly also to private lawsuits for redress of HOEPA violations, insufficiently clear rules could create legal and regulatory uncertainty and have the unintended effect of substantially reducing legitimate subprime lending. Next month, we will conduct a public hearing to consider how we might further use our HOEPA authority to curb abuses while preserving access to credit. We have invited people representing all sides of the debate to present their views.

We have also used, and will continue to use, supervisory guidance to help mitigate problems in the subprime sector. Earlier this year, the Board and other federal bank and thrift regulators issued draft supervisory guidance to address concerns about underwriting and disclosure practices, particularly of subprime ARMs. Many industry and consumer groups have responded to our proposal, and we are now reviewing the comments. Regulators in 1999 issued guidance on subprime lending and in 2001 expanded that guidance. Last year, we issued guidance concerning so-called nontraditional mortgages, such as interest-only mortgages and option ARMs. For both subprime and nontraditional mortgages, our guidance has reminded lenders of the importance of maintaining sound underwriting standards and of providing consumers with clear, balanced, and timely disclosures about the risks and benefits of these mortgages.

The patchwork nature of enforcement authority in subprime lending--in particular, the fact that the authority to make rules and the responsibility to enforce those rules are often held by different agencies--poses additional challenges. For example, rules issued by the Board under TILA or HOEPA apply to all mortgage lenders but are enforced--depending on the lender--by one of five federal regulators of depository institutions, the Federal Trade Commission (FTC), or state regulators. To ensure consistent and effective enforcement, close cooperation and coordination among the regulators are essential. The Board remains committed to working closely with other regulators to achieve uniform and effective enforcement. We can continue to improve the sharing of information and the coordination of some activities, such as examiner training, through the Federal Financial Institution Examination Council, which the Conference of State Banking Supervisors (CSBS) recently joined, as well as through other channels, such as the CSBS’s State/Federal Working Group. We will also draw on the expertise of other regulators as we consider changes in required disclosures and rules.

Macroeconomic Implications
The problems in the subprime mortgage market have occurred in the context of a slowdown in overall economic growth. Real gross domestic product has expanded a little more than 2 percent over the past year, compared with an average annual growth rate of 3-3/4 percent over the preceding three years. The cooling of the housing market is an important source of this slowdown. Sales of both new and existing homes have dropped sharply from their peak in the summer of 2005, the inventory of unsold homes has risen substantially, and single-family housing starts have fallen by roughly one-third since the beginning of 2006. Although a leveling-off of sales late last year suggested some stabilization of housing demand, the latest readings indicate a further stepdown in the first quarter. Sales of new homes moved down to an appreciably lower level in February and March, and sales of existing homes have also come down on net since the beginning of this year.

How will developments in the subprime market affect the evolution of the housing market? We know from data gathered under the Home Mortgage Disclosure Act that a significant share of new loans used to purchase homes in 2005 (the most recent year for which these data are available) were nonprime (subprime or near-prime). In addition, the share of securitized mortgages that are subprime climbed in 2005 and in the first half of 2006. The rise in subprime mortgage lending likely boosted home sales somewhat, and curbs on this lending are expected to be a source of some restraint on home purchases and residential investment in coming quarters. Moreover, we are likely to see further increases in delinquencies and foreclosures this year and next as many adjustable-rate loans face interest-rate resets. All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system. The vast majority of mortgages, including even subprime mortgages, continue to perform well. Past gains in house prices have left most homeowners with significant amounts of home equity, and growth in jobs and incomes should help keep the financial obligations of most households manageable.

Conclusion
Credit market innovations have expanded opportunities for many households. Markets can overshoot, but, ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit.

We at the Federal Reserve will do all that we can to prevent fraud and abusive lending and to ensure that lenders employ sound underwriting practices and make effective disclosures to consumers. At the same time, we must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers. Together with other regulators and the Congress, our success in balancing these objectives will have significant implications for the financial well-being, access to credit, and opportunities for homeownership of many of our fellow citizens.


Footnotes

1. This estimate is based on data from the Mortgage Bankers Association, adjusted to reflect the limited coverage of the association’s sample. Return to text

2. Near-prime loans include those securitized in "alt-A" pools and similar loans that are held on lenders’ books. Return to text

3. Estimates of delinquencies are based on data from First American LoanPerformance. The rate of serious delinquencies for variable-rate subprime mortgages also reached about 11 percent in late 2001 and early 2002. Return to text

4. Foreclosure starts are based on data from the Mortgage Bankers Association, adjusted to reflect the limited coverage of their sample. Return to text

5. Many mortgage brokers are subject to minimum licensing standards and bonding or net worth criteria, but these standards and criteria vary across states. Return to text

6. For home refinance loans, the Board can prohibit practices that it finds to be associated with abusive practices or not in the best interest of the borrower. Return to text

7. The results of the review of disclosures for open-end credit and the associated notice of proposed rule-making will be discussed at an open meeting of the Board of Governors on May 23, 2007. Return to text

20070517 Bernanke at the Federal Reserve Bank of Chicago’s 43rd Annual Conference