Bernanke tackles the subprime meltdown
I'm back in the office today, so hopefully I'll have more time to post. One big development today I'd like to blog about is Fed Chairman Ben Bernanke's speech about the subprime mortgage market. His basic points (I'm paraphrasing here because the actual language, like that found in most Fed speeches, might put you to sleep):
* Subprime mortgage lending has been around for a couple of decades, but really began to explode in the mid 1990s.
* Credit scoring and the ability to offload risk to end investors helped fuel the boom. It made it cheaper to originate loans and easier to shunt the credit risk of high-risk loans elsewhere into the financial netherworld.
* There are roughly 7.5 million subprime mortgages in first-lien position, 14% of the overall market. Alt-A/near prime loans are another 8% to 10% of the market.
* Giving higher risk loans to a bunch of people who couldn't previously buy homes helped drive the homeownership rate to 69% last year from 65% in 1995. But ... oops ... a lot more of those borrowers actually can't afford those loans, so they're defaulting.
* Now, even more borrowers than you might expect are defaulting. That's because ...
A) These extremely risky loans are starting to season (in non-jargon terms, they're getting older and entering the age bracket where defaults typically rise anyway)
B) House price appreciation has ground to a halt in some places. In other markets, prices are falling outright.
C) Interest rates have risen.
D) More homes are in the hands of investors. Those owners are more likely to walk away when the going gets tough.
E) The overall economy has slowed, with certain sectors like the automobile business, particularly hard hit.
F) Lenders began to give mortgages to anyone with a pulse once all the better-credit borrowers had been tapped out.
* While subprime lenders are dropping like flies and lending conditions have tightened up, Bernanke maintained the meltdown hasn't threatened the broader banking industry. The Fed is encouraging lenders to work with borrowers, by modifying loan terms or taking other steps, to help them avoid foreclosure and minimize losses.
What about possible policy responses? Here I'll quote Bernanke directly:
"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."
* As for the housing market itself, Bernanke admits that things aren't so hot. Sales are down big, inventories of unsold homes have surged, and starts of new homes have slumped sharply. Since subprime and nonprime loans accounted for a fair share of home purchases in 2005 and 2006, tighter credit standards will "be a source of some restraint."
Lastly, Bernanke wrapped things up by saying ...
"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."
MY TAKE? Once again, the Fed is a day late and a buck short. Where were these guys when private analysts, myself included, were shouting from the rooftops about a housing bubble? Why didn't they go further than just issue weak-kneed guidance? Why didn't they jawbone the heck out of mortgage lenders and speculative real estate investors in 2003, 2004, and 2005? Or jack up interest rates by more than 25 points at a time when it became clear to everyone involved that housing prices had gone parabolic? The failure of policymakers and regulators to attack the housing and lending bubbles before they got out of control is simply unconscionable.
* Subprime mortgage lending has been around for a couple of decades, but really began to explode in the mid 1990s.
* Credit scoring and the ability to offload risk to end investors helped fuel the boom. It made it cheaper to originate loans and easier to shunt the credit risk of high-risk loans elsewhere into the financial netherworld.
* There are roughly 7.5 million subprime mortgages in first-lien position, 14% of the overall market. Alt-A/near prime loans are another 8% to 10% of the market.
* Giving higher risk loans to a bunch of people who couldn't previously buy homes helped drive the homeownership rate to 69% last year from 65% in 1995. But ... oops ... a lot more of those borrowers actually can't afford those loans, so they're defaulting.
* Now, even more borrowers than you might expect are defaulting. That's because ...
A) These extremely risky loans are starting to season (in non-jargon terms, they're getting older and entering the age bracket where defaults typically rise anyway)
B) House price appreciation has ground to a halt in some places. In other markets, prices are falling outright.
C) Interest rates have risen.
D) More homes are in the hands of investors. Those owners are more likely to walk away when the going gets tough.
E) The overall economy has slowed, with certain sectors like the automobile business, particularly hard hit.
F) Lenders began to give mortgages to anyone with a pulse once all the better-credit borrowers had been tapped out.
* While subprime lenders are dropping like flies and lending conditions have tightened up, Bernanke maintained the meltdown hasn't threatened the broader banking industry. The Fed is encouraging lenders to work with borrowers, by modifying loan terms or taking other steps, to help them avoid foreclosure and minimize losses.
What about possible policy responses? Here I'll quote Bernanke directly:
"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."
* As for the housing market itself, Bernanke admits that things aren't so hot. Sales are down big, inventories of unsold homes have surged, and starts of new homes have slumped sharply. Since subprime and nonprime loans accounted for a fair share of home purchases in 2005 and 2006, tighter credit standards will "be a source of some restraint."
Lastly, Bernanke wrapped things up by saying ...
"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."
MY TAKE? Once again, the Fed is a day late and a buck short. Where were these guys when private analysts, myself included, were shouting from the rooftops about a housing bubble? Why didn't they go further than just issue weak-kneed guidance? Why didn't they jawbone the heck out of mortgage lenders and speculative real estate investors in 2003, 2004, and 2005? Or jack up interest rates by more than 25 points at a time when it became clear to everyone involved that housing prices had gone parabolic? The failure of policymakers and regulators to attack the housing and lending bubbles before they got out of control is simply unconscionable.
posted by Mike Larson at
12:46 PM
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