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Bernanke Sees Limited Spillover From Subprime Woes
In a May 17 address to a Chicago Federal Reserve Bank conference, Fed Chairman Ben S. Bernanke said that curbs on sub-prime residential mortgage lending in response to rising delinquencies and foreclosures are likely to restrain home buying and residential investment in coming business quarters, but suggested that the damage to housing and the nation’s economy will be limited.
“Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the sub-prime sector 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,” Bernanke said.
The focus of Bernanke’s remarks was on how the Federal Reserve, other regulators and the Congress should respond to the current sub-prime problem.
“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,” he said.
“At the same time, we must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers.”
While mortgage credit in general has been “very solid” in recent years, he said, subprime mortgages with adjustable interest rates in foreclosure or with payments overdue by 90 days or more were up sharply last year and recently stood at 11%, about double their recent low in mid-2005.
In the final quarter of last year, subprime mortgages accounted for more than half of the 310,000 foreclosure proceedings that were initiated. For the two preceding years, the average quarterly rate was roughly 230,000.
Adjustable-rate subprime mortgages currently account for about two-thirds of subprime first lien mortgages and about 9% of all first-lien mortgages outstanding.
“As the problems in the subprime mortgage market have become manifest, we have seen some signs of self-correction in the market,” Bernanke said. “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 sub-prime originations have slowed.
According to the Fed’s Senior Loan Officer Opinion Survey on Bank Lending Practices in April, a large majority of respondents indicated that standards on prime residential mortgages had remained basically unchanged over the past three months, with 14% reporting somewhat tighter standards.
Of the 44 domestic institutions that originated nontraditional residential mortgages, 45% noted a tightening of standards on those loans. Of the 16 institutions indicating that they had originated supprime residential mortgages, more than half of the respondents, on net, reported that they had tightened standards on those loans.
“Tighter standards on subprime and nontraditional mortgage loans generally were not associated with a move toward more-stringent lending policies for prime mortgages,” the report found.
“Indeed, of the nine institutions that reported having tightened standards on subprime residential mortgages, only one indicated that it had also tightened standards on prime residential mortgages. Five of the 20 institutions that reported tightening standards on nontraditional mortgages also tightened standards on prime mortgages,” the report said.
Bernanke said that although the supply of credit to the subprime market has been reduced, “credit has by no means evaporated.”
“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,” he said. “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.”
Looking at the nation’s housing market, Bernanke described “a further stepdown in the first quarter” of this year after a leveling-off of sales toward the end of 2006 suggested some stabilization of housing demand. “Sales of new homes moved down to an appreciably lower level in February and March,” he said, “and sales of existing homes have also come down on net since the beginning of this year.”
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