by Calculated Risk on 9/20/2007 11:19:00 AM

Fed Chairman Ben Bernanke testified before the House Committee on Financial Services this morning: Subprime mortgage lending and mitigating foreclosures. A few excerpts:

During the past two years, serious delinquencies among subprime adjustable-rate mortgages (ARMs) have increased dramatically. (Subprime mortgages with fixed rates, on the other hand, have had a more stable performance.) The fraction of subprime ARMs past due ninety days or more or in foreclosure reached nearly 15 percent in July, roughly triple the low seen in mid-2005.1 For so-called near-prime loans in alt-A securitized pools (those made to borrowers who typically have higher credit scores than subprime borrowers but still pose more risk than prime borrowers), the serious delinquency rate has also risen, to 3 percent from 1 percent only a year ago. These patterns contrast sharply with those in the prime-mortgage sector, in which less than 1 percent of loans are seriously delinquent.

In July Bernanke argued that what started in subprime would stay in subprime. He was wrong. Now he is arguing that the problems will be contained to subprime and "near prime" loans. More likely delinquency rates will increase in all categories as house prices fall.

The Federal Reserve takes responsible lending and consumer protection very seriously. Along with other federal and state agencies, we are responding to the subprime problems on a number of fronts. We are committed to preventing problems from recurring, while still preserving responsible subprime lending.

The Fed's job was to prevent these problems from "occurring". Preventing them from "recurring" is a tacit acknowledgment of the Fed's earlier failures.

On raising the GSE conforming limit:

Some have suggested that the GSEs could help restore functioning in the secondary markets for non-conforming mortgages (specifically jumbo mortgages, those with principal value greater than $417,000) if the conforming-loan limits were raised. However, in my view, the reason that GSE securitizations are well-accepted in the secondary market is because they come with GSE-provided guarantees of financial performance, which market participants appear to treat as backed by the full faith and credit of the U.S. government, even though this federal guarantee does not exist. Evidently, market participants believe that, in the event of the failure of a GSE, the government would have no alternative but to come to the rescue. The perception, however inaccurate, that the GSEs are fully government-backed implies that investors have few incentives in their role as counterparties or creditors to act to constrain GSE risk-taking. Raising the conforming-loan limit would expand this implied guarantee to another portion of the mortgage market, reducing market discipline further.

In general I agree with Bernanke's comments on the GSEs and conforming limits. It might be reasonable to have different limits for different areas, based on the median income for each area.

There is much more in the speech.

by Calculated Risk on 9/11/2007 11:01:00 AM

From Fed Chairman Ben Bernanke: Global Imbalances: Recent Developments and Prospects. Bernanke provides an update on his "savings glut" explanation of current global imbalances.

... the current pattern of external imbalances--the export of capital from the developing countries to the industrial economies, particularly the United States--may prove counterproductive over the longer term. I noted some reasons for concern in my earlier speech, and they remain relevant today.

First, the United States and other industrial economies face the prospect of aging populations and of workforces that are growing more slowly. These trends enhance the need to save (to support future retirees) and may reduce incentives to invest (because workforces eventually will shrink). If the United States saved more, one likely outcome would be a reduction in the U.S. current account deficit and in the rate at which the country is adding to its liabilities to the rest of the world.

Second, the large U.S. current account deficit cannot persist indefinitely because the ability of the United States to make debt service payments and the willingness of foreigners to hold U.S. assets in their portfolios are both limited. Adjustment must eventually take place, and the process of adjustment will have both real and financial consequences. For example, in the United States, the growth of export-oriented sectors such as manufacturing has been restrained by the shifts in relative prices and foreign demand associated with the U.S. trade deficit. Ultimately, the necessary reduction in the trade and current account deficits will entail shifting resources out of sectors producing nontraded goods and services to those producing tradables. The greater the needed adjustment, the more potentially disruptive and costly these shifts may be. Similarly, external adjustment for China and other surplus countries will involve shifting resources out of the export sector and into industries geared toward meeting domestic consumption needs; that necessary shift, too, will likely be less disruptive if it occurs earlier and thus less rapidly and on a smaller scale.

On the financial side, if U.S. current account deficits were to persist at near their current levels, foreign investors would ultimately become satiated with dollar assets, and financing the deficit at a reasonable cost would become difficult. Earlier reduction of global imbalances would reduce the potential strains associated with financing a large quantity of international liabilities and likely allow a smoother adjustment in financial markets.

Finally, in the longer term, the developing world should be the recipient, not the provider, of financial capital. Because developing countries tend to have high ratios of labor to capital and to be away from the technological frontier, the potential returns to investment in those countries is high. Thus, capital flows toward those countries should benefit both them and the countries providing the capital.

Bernanke didn't offer any clues as to the direction of monetary policy.