Thursday, September 20, 2007

Bernanke: Subprime mortgage lending and mitigating foreclosures

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.