Thank you from FDIC and the Financial Services Committee:
Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on Recent Events in the Credit and Mortgage Markets and Possible Implications for U.S. Consumers and the Global Economy before the Financial Services Committee, U.S. House of Representatives; 2128 Rayburn House Office Building
Chairman Frank, Ranking Member Bachus, and members of the Committee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on the credit and mortgage markets. Events in the financial markets over this summer present all of us here today -- regulators, policymakers, and industry -- with serious challenges. The FDIC is committed to working with Congress and others to ensure that the banking system remains sound and that the broader financial system is in position to meet the credit needs of the economy, especially those of creditworthy households currently in distress. In my testimony today, I will discuss the developments that led to the current market disruptions, report on the condition of the banking industry, and describe ways to address some of the lessons we have learned from the events of recent months.
The Roots of the Current Problem (to be continued below...)
The
chronology of the events that have led up to the present situation
demonstrates how weak credit practices in one sector can lead to a
wider set of credit market uncertainties that could affect the broader
economy. Although these events have yet to fully play out, they
underscore my longstanding view that consumer protection and safe and
sound lending are really two sides of the same coin. Failure to uphold
uniform high standards in these areas across our increasingly diverse
mortgage lending industry has resulted in serious adverse consequences
for consumers, lenders, and, potentially, the U.S. economy.
At the beginning of the most recent mortgage lending growth period, in
2002 and 2003, we witnessed a record boom in the volume of mortgage
originations, driven primarily by the refinancing of existing
mortgages. By mid-2003, as long-term mortgage interest rates fell
toward generational lows, virtually every fixed-rate mortgage in
America became a candidate for refinancing. The result was a wave of
refinancing activity that was dominated by prime, fixed-rate loans.
During 2003, some 64 percent of all mortgage applications were for
refinancing, and over 80 percent were for fixed-rate loans. By the end
of 2003, more than three quarters of U.S. mortgages included in
non-agency securitizations were less than three years old.
With lower interest rates came higher rates of home price appreciation.
As measured by the OFHEO Home Price Index, U.S. home price appreciation
measured 5 percent or less in every year during the 1990s. But starting
in 2000, U.S. home price appreciation rose to annual rates of between 6
percent and 8 percent followed by double-digit increases in both 2004
and 2005. This home price boom was concentrated at first in
metropolitan areas of California, the Northeast, and Florida, and it
then spread by the middle of the decade to much of the Mountain West
and other cities further inland. While home prices were effectively
doubling in a number of boom markets, median incomes grew much more
slowly, severely reducing the affordability of home ownership despite
the benefit of historically low interest rates.
Changes in Mortgage Lending
Home price appreciation helped set the stage for dramatic changes in
the structure and funding of U.S. mortgage loans. To the extent that
prime borrowers with a preference for fixed rates had already locked in
their loans by 2003, the mortgage industry began to turn its attention
-- and its ample lending capacity -- toward less creditworthy borrowers
and home buyers struggling to cope with the high cost of housing. One
result was a shift in the overall market from refinancing toward
purchase financing, which rose to more than half of originations in
2004, 2005, and 2006. Another result was a larger share of originations
for subprime loans, which more than doubled in 2004 to 18 percent of
originations and then peaked at just over 20 percent in 2005 and 2006.
Declining affordability in high-priced housing markets also contributed
to a shift toward nontraditional loans such as interest-only and
payment-option mortgages. Among mortgages packaged in non-agency
securitizations, nontraditional mortgages rose from just 3 percent of
nonprime originations in 2002 to approximately 50 percent by early
2005.1
The growth in nontraditional lending was associated with a larger
expansion in so-called "Alt-A" mortgages, or loans made to presumably
creditworthy borrowers where the terms and/or documentation of the loan
fall short of the requirements placed on "conforming" loans.2 In
addition, borrowers who lacked the requisite 20 percent down payment
required for conforming loans could, in the nonconforming market,
arrange to borrow their down payment through a second mortgage, or
piggyback loan, and thereby avoid the cost of mortgage insurance that
has traditionally been imposed on borrowers with high loan-to-value
ratios. While nontraditional mortgages, subprime mortgages, and home
equity loans were not new to the marketplace in 2004, they had never
been originated on such a wide scale prior to this time.
Expansion of nonconforming mortgage lending has been facilitated by an
increasingly diverse set of origination and funding channels.
Origination channels include both FDIC-insured institutions and their
finance company affiliates, as well as mortgage brokers and stand-alone
finance companies that fall outside direct federal supervision. Funding
channels include banks and thrift institutions, the housing-related
Government Sponsored Enterprises (GSEs), GSE-sponsored mortgage pools,
and, increasingly, private issuers of asset-backed securities (ABS).
But an unmistakable trend that stands out as a driver of the changes we
have seen in the mortgage industry has been the rise in the share of
mortgages funded by ABS issuers, which rose from 8.5 percent in 2003 to
18.7 percent by 2006.3 The availability of funding through private ABS
facilitated growth in the "originate and sell" business model, under
which a broad range of brokers and correspondents participate in
originating mortgage loans without the need to provide permanent
financing themselves. This model was pioneered by lenders selling
conforming mortgages to the GSEs, but in recent years private ABS
issuance has become a primary channel for the funding of subprime and
Alt-A mortgage loans. Subprime and Alt-A loans together stood behind 77
percent of all private ABS outstanding as of May of this year.4
In the absence of GSE sponsorship, private ABS issuers were able to
enhance the marketability of their obligations by structuring them into
senior and subordinate tranches. The end result of this process was the
creation of trillions of dollars in investment grade mortgage-backed
securities (MBS) that were purchased by a range of domestic and
international investors, along with a smaller volume of higher-risk
securities that were better suited to hedge funds and other investors
with an appetite for yield and a greater tolerance for risk.
In hindsight, it is clear that the strong performance of these
securities -- both in senior and subordinate tranches -- during the
period of low interest rates and rapid home price appreciation helped
to obscure their true risk. While times were good, an excess volume of
credit flowed to mortgages in general and nonconforming mortgages in
particular. Ready access to market-based funding, in turn, contributed
to what is recognized now as a serious weakening of underwriting
practices. This deterioration of underwriting practices is perhaps best
described by the term "risk layering," which regulators have used to
describe the practice of allowing a number of different potentially
risky underwriting attributes (such as low credit score, high
loan-to-value, low or no documentation of income, etc.) in the same
loan. These practices tend to compound the risk of default,
particularly when permitted in combination. As long as home prices were
rising, even these layered risks were often overlooked by lenders,
borrowers, and investors. Rising prices delivered capital gains to
existing homeowners that could be tapped through home equity loans or
"cash-out" refinancing, thereby making default a relatively rare
occurrence.
Another consequence of the easy credit availability afforded by lower
underwriting standards and rising home prices was an increase in both
the misuse of credit by speculators and perpetrators of fraud. While
housing booms inevitably attract speculative investment, the prevalence
of low documentation, low down payment loans in this cycle dramatically
lowered the barriers to entry in this segment of the housing market.
During 2006, loans to investors or for second homes made up a reported
7 percent on non-agency subprime securitized mortgages.5 FBI data show
that the number of suspicious activity reports (SARs) indicating
mortgage fraud rose from fewer than 7,000 in 2003 to more than 35,000
in 2006.6
Meanwhile, the increasingly diverse array of loan types available to
borrowers in this cycle invited unscrupulous lenders to impose onerous
terms on less sophisticated borrowers who might not fully understand
the true costs and risks of these loans. The culmination of this
process was the subprime hybrid "2/28" or "3/27" mortgage, which
typically combines a substantial increase in the interest rate and
monthly payment on the loan after the initial two to three year starter
period with a substantial prepayment penalty that limits the ability of
the borrower to refinance the loan until that starter period is over.
Third party estimates of monthly payment "resets" on subprime
adjustable-rate mortgages (ARMs) through year-end 2008 suggest the
potential for serious financial distress for over 1.5 million
households.7 The Mortgage Bankers Association estimates that nearly
490,000 subprime loans were already seriously delinquent or in
foreclosure as of March 2007.8
These looming payment resets are just one of a series of ongoing
developments that amply demonstrate the consequences of failing to
uphold a strong, uniform set of lending and underwriting standards
across the mortgage industry. The transactional nature of the
"originate and sell" model has contributed to lending practices that
have damaged the immediate interests of consumers, mortgage lenders and
mortgage investors, and now pose a risk to the broader economy. The
housing boom has given way to declining home prices in an expanding
list of U.S. metropolitan areas. Mortgage delinquencies and
foreclosures are on the rise not only in subprime portfolios, but also
in Alt-A portfolios, where risk layering is now contributing to credit
problems that are no longer being masked by home price appreciation.
The Impact of Poor Mortgage Underwriting on Other Markets
The full dimensions of the problem in mortgage markets started to
become clear late last year, as analysts noted the marked deterioration
in the performance of recent loan originations. However, it was not
until the middle of this year that we began to see a substantial number
of downgrades in the credit ratings of some types of MBS. These
downgrades have contributed to generalized uncertainty about the value
of MBS and have in turn triggered redemptions at hedge funds, margin
calls, and episodes of illiquidity in commercial paper and other areas
of global financial markets.
Since the beginning of June 2007, the securities rating agencies have
downgraded more than 2,400 tranches of residential MBS. Ratings
downgrades led to decreased liquidity for many financial assets, not
just those known to have problems. For example, the liquidity for MBS
that were downgraded declined, but so did the liquidity for many
securities where the ratings remained unchanged. The uncertainty that
now pervades this market -- which is directly attributable to
underwriting practices that are unsafe, unsound, predatory and/or
abusive -- has seriously disrupted the functioning of the
securitization market and the availability of mortgage credit.
Investor concern about ratings has become particularly acute in the
markets for Asset-Backed Commercial Paper (ABCP) and repurchase
agreements -- investments where credit risk is expected to be low and
liquidity to be high. Investors' trust in the ratings assigned to the
bonds and other assets used as collateral for ABCP and repurchase
agreements has been integral to the orderly and efficient working of
these markets. However, when ratings came into question, investors
redeemed these investments and sought safety in short-term Treasury
securities. During the third week in August, the volume of commercial
paper outstanding dropped $90 billion, or 4.23 percent, the largest
percentage decline since 2000. Almost 80 percent of the decline was in
ABCP, which accounts for about half of all commercial paper. When
commercial paper investors could not be found, some ABCP issuers were
forced to use liquidity backstop funding to finance assets causing the
rates on commercial paper to increase. Risk aversion among commercial
paper investors caused them to err on the side of caution when deciding
which ABCP to renew.
Credit concerns now extend more broadly to leveraged commercial
lending.9 During August 2007, credit market conditions became more
challenging as investors and lenders worked to understand where the
concentrations of credit risk would be most problematic. Most
vulnerable were highly leveraged, poorly diversified and illiquid
entities, including some hedge funds which had been buyers of
syndicated loans. Illiquidity in the non-agency MBS market caused some
fund managers to meet margin calls by selling non-distressed assets,
contributing to weaker asset prices beyond the mortgage markets.
Uncertainty about future asset prices reduced the appetite for funding
for various asset classes, including leveraged loans. In some cases,
originators were unable to find buyers for these loans and had no
choice but to fund loans that they had originally intended to hold
temporarily. Linkages between the credit and equity markets also became
more apparent as the ability to raise debt funding to take public
companies private came into question, causing the equity prices of
targeted companies to decline.
The Current Condition of the Banking Industry
Because insured financial institutions entered this period of
uncertainty with strong earnings and capital, they are in a better
position both to absorb the current stresses and to provide much needed
credit as other sources withdraw. It is in times of financial stress
that the role of federal deposit insurance becomes evident in promoting
stability. Insured deposit accounts give consumers a safe place to put
their money during times of uncertainty, and confidence in the safety
of their deposits helps to preserve the liquidity and integrity of the
financial system.
As the current period of financial stress began, both the banking
industry and the deposit insurance system were sound. Two weeks ago,
the FDIC released second quarter 2007 financial results for the 8,615
FDIC-insured commercial banks and savings institutions. The results
reported in the Quarterly Banking Profile describe an industry with
very solid performance. Second-quarter earnings were the fourth highest
quarterly total on record -- only 3.5 percent below the all-time high.
Also, the industry's return on assets of 1.21 percent remained strong
by historical standards. Although the number of unprofitable
institutions increased during the quarter, more than 90 percent of all
FDIC-insured institutions were profitable. Nearly all institutions
could be considered "well capitalized" according to the standards for
Prompt Corrective Action, and the industry's leverage ratio remained
above 8 percent.
Yet, it is clear that conditions for banks and thrifts are not as
favorable as in the recent past. The interest rate environment
continues to be difficult for financial institutions. More than two out
of three institutions reported net interest margins in the second
quarter that were below levels reported at the same time last year. The
industry continues to generate strong noninterest income -- in the most
recent quarter, noninterest income was 9 percent higher than a year
earlier. However, some components of noninterest income, such as
trading revenue and investment banking fees, can be subject to downward
movements in times of credit market distress.
Of most concern, credit quality is likely to get worse before it gets
better. Net charge-offs totaled $9.2 billion in the second quarter --
the highest quarterly total since the fourth quarter of 2005 -- and
were 51 percent higher than in the second quarter of 2006. Net
charge-offs of 1-4 family residential mortgage loans increased 144
percent from the prior year period, to $715 million. Noncurrent (90
days or more past due or in nonaccrual status) 1-4 family residential
mortgage loans represented 1.26 percent of all such loans at the end of
June -- the highest noncurrent rate for these loans since the first
quarter of 1994.
Based on the challenges facing the banking industry, it is important to
consider what recent market events may mean for banks and thrifts going
forward. The current situation mostly affects lenders who rely on the
"originate and sell" model, and this way of doing business is under
intense pressure. There is a chance that larger volumes of loans may
find their way onto bank and thrift balance sheets than has been the
case in recent years. In some cases, insured institutions may choose to
grow their loan portfolios. In other situations, banks may find
themselves holding assets on a long-term basis that they planned to
fund only on a short-term basis, if at all.
Many credit needs will have to be funded in the coming months. In terms
of mortgage credit, an estimated $353 billion in subprime mortgages
will reset between now and the end of 2008.10 Opportunities may exist
to originate and hold a range of nonconforming mortgage loans for which
secondary market liquidity has receded. The commercial loan portfolios
of banks and thrifts are also likely to expand as a result of a more
difficult secondary market for commercial credit. Total outstanding
commitments to fund U.S. leveraged loan deals in the second half of
2007 have been estimated at approximately $200 billion.11 Moreover, the
issuers of the approximately $1 trillion in ABCP outstanding may
increasingly look to depository institutions as an alternative
financing source when this paper comes due. Some of the leveraged loans
and ABCP may reach insured institutions' balance sheets directly, as
banks fund these deals through previously established backup financing
arrangements, retain credits they originally intended to sell, or
purchase this paper in the open market.
The problems in the credit markets represent both a challenge and an
opportunity for FDIC-insured depository institutions. Among the
challenges for the industry are the increased credit losses that
already exist and are likely to continue in coming quarters. If the
housing downturn continues, some institutions that are currently in
good shape could face capital challenges resulting from losses in
mortgage related assets. In general, however, the industry is
well-positioned to manage these losses. This situation may also create
opportunities for insured institutions to expand market share and
improve interest margins as some credit market funding shifts from the
secondary market to banks and thrifts. Growth of portfolios, if it
occurs, would pose a risk management challenge for many institutions,
and institutions that expand their loan portfolios will have to
maintain sufficient capital to support that growth. However, the
currently strong capital base of the industry places it in a position
to be a more important source of financing for U.S. economic activity
through this difficult period.
Addressing the Problems
A full evaluation of lessons learned from this episode will require
more time and more study. However, there are a number of near-term
priorities that should be pursued now to minimize the adverse
consequences of the present turmoil and begin to lay the groundwork for
a more vigilant and more uniform regulatory approach going forward. In
the near term, the FDIC will continue to fulfill its roles as
supervisor and deposit insurer by defining and enforcing appropriate
lending standards, working to suggest options for borrowers who find
themselves facing financial distress, and monitoring the condition of
insured institutions.
The FDIC continues to closely monitor the situation in the markets.
While others -- including several of my counterparts at the table today
-- are working to address the broader market issues, the FDIC will
continue to play a significant role as the primary federal regulator of
5,214 commercial banks and state savings banks and as the deposit
insurer for 8,615 banks and thrifts. Most of the largest mortgage
lenders either are, or are affiliated with, an insured depository
institution. Federal deposit insurance will assure the continued
viability of a source of funding and liquidity -- in the form of
deposits -- that is a vital underpinning of our financial system.
Improving Lending Standards
The FDIC and other federal banking agencies conduct regular
examinations, monitoring and reporting on the mortgage activities of
insured institutions. Further, the agencies have taken a series of
steps to address developments in the mortgage market from both a safety
and soundness and a consumer protection perspective. For example, in
September 2006, the agencies issued Interagency Guidance on
Nontraditional Mortgage Product Risks to address concerns about
offering interest-only and payment-option adjustable rate mortgages to
borrowers for whom they were not originally designed. The guidance not
only reminded bankers to carefully manage the risks associated with
these products, it also emphasized that consumers should be provided
with clear and accurate information about these products at the time
they are choosing a loan or deciding which payment option to select.
On January 22, 2007, the FDIC issued its Supervisory Policy on
Predatory Lending that describes certain characteristics of predatory
lending and reaffirms that such activities are inconsistent with safe
and sound lending and undermine individual, family, and community
economic well being. The policy also describes the FDIC's supervisory
response to predatory lending, including a list of policies and
procedures that relate to consumer lending standards.
Since the subprime market raised additional concerns, the agencies
issued a Statement on Subprime Mortgage Lending on June 29, 2007. This
statement makes clear that lenders should follow two fundamental
consumer protection principles when underwriting and marketing
mortgages. First, a loan should be approved based on a borrower's
ability to repay it according to its terms (e.g., not just at the
initial rate). Second, consumers should be provided with the
information necessary to help them decide if a loan is appropriate for
their needs. The statement cautions that such communications should not
be used to steer consumers to subprime products to the exclusion of
other institution products for which consumers may qualify. Relying on
these principles, lenders can offer mortgages that meet the needs of
most subprime customers in a safe and sound manner.
Although the FDIC and others recognized the changing nature of the
mortgage lending industry, it is fair to say that the regulatory
community, ratings firms, and others in the industry failed to fully
appreciate the depth of the underwriting problems and the severity of
subprime payment resets until late last year. Even though it was not
reasonable to expect that home prices would continue to rise at double
digit rates indefinitely, many of the emerging risks were masked by
home appreciation. However, it also was apparent that subprime and
nontraditional mortgages were growing asset classes that could expose
many borrowers to payment shock. Seeing this, consumer advocacy groups
were among the first to suggest that changes in the market might lead
to more delinquencies and foreclosures.
Assisting Troubled Borrowers
The federal banking agencies have been working together for many months
to address issues surrounding subprime mortgages, especially the
possibility of increased foreclosures, and we have sought ways to help
creditworthy borrowers who are currently in mortgages that are or soon
will be unaffordable. In April, the FDIC and the federal banking
agencies issued a Statement on Working with Mortgage Borrowers, which
encourages financial institutions to work constructively with
residential borrowers who are financially unable to make their home
loan payments. The June Statement on Subprime Mortgage Lending
reinforces the April Statement, encouraging institutions to work
constructively with residential borrowers with troubled loans. In
addition, in July, the agencies issued proposed updates to the
Interagency Questions and Answers Regarding Community Reinvestment,
including revisions which highlight that institutions can receive CRA
consideration for foreclosure prevention programs for low- and
moderate-income homeowners, consistent with the April and June
Statements.
The FDIC, along with the other banking agencies, has jointly hosted a
series of forums on the issues surrounding subprime mortgage
securitizations. These forums have engaged market participants at every
level in identifying barriers to working with borrowers to avoid
foreclosure and developing solutions to permit borrowers to retain
their homes. Importantly, every forum participant agreed that
foreclosure of owner-occupied homes was rarely the best option for
investors or borrowers.
Building on the information learned from these meetings with
participants in the securitization markets, yesterday, the FDIC, the
other federal banking agencies, and CSBS issued a Statement on Loss
Mitigation Strategies for Servicers of Residential Mortgages that
provides instructions to the agencies' supervised institutions
servicing securitized mortgage loans. The Statement urges institutions
to review the governing documents for the securitization trusts to
determine the full extent of their authority to restructure loans at
risk of default. Most securitization documents allow servicers to
proactively contact borrowers at risk of default, assess whether
default is reasonably foreseeable, and, if so, apply loss mitigation
strategies designed to achieve sustainable mortgage obligations that
keep borrowers in their homes to the extent possible. The Securities
and Exchange Commission and the U.S. Department of the Treasury have
indicated that such servicing activities are consistent with acceptable
accounting practices and controlling tax principles. As significant
numbers of hybrid adjustable rate mortgages are scheduled to reset
throughout the remainder of this year and next, the FDIC is encouraging
institutions servicing such loans to carefully review the authority
they have under the governing agreements and pursue prudent loan
restructurings with borrowers to avoid unnecessary foreclosures.
It is equally important that when working with financially stressed
residential borrowers, servicers should avoid temporary measures that
do not address the borrower's ongoing difficulty with unaffordable
payments. Institutions are encouraged to work toward long-term
sustainable and affordable payment obligations that will provide
stability for servicers and investors as well as borrowers. Clearly,
fixed rate obligations provide the best opportunity to long-term
stability. In developing a strategy to address payment difficulties, it
is essential that servicers, as well as lenders, realistically evaluate
the borrower's ability to repay the modified loan. One methodology
commonly used by servicers is an analysis of the borrower's resulting
debt-to-income (DTI) ratio. The DTI ratio should include the customer's
total monthly housing-related payments (i.e., principal, interest,
taxes, and insurance) as a percentage of their gross monthly income. In
issuing the interagency statement, the FDIC and CSBS noted that, absent
mitigating circumstances, resulting DTI ratios exceeding 50 percent
will increase the likelihood of future difficulties in repayment and
delinquencies or defaults.
Another effort to help troubled homeowners involves the FDIC's Alliance
for Economic Inclusion. The Alliance is the FDIC's national initiative
to form a network of local coalitions around the country charged with
helping underserved populations in nine particular markets across the
United States. As part of this effort, the Alliance for Economic
Inclusion has partnered with NeighborWorks® America's Center for
Foreclosure Solutions to promote foreclosure-prevention strategies for
consumers at risk of foreclosure. Within each of the nine markets, the
partnership is conducting outreach to identify and help homeowners at
risk of foreclosure, work to increase lenders' support for foreclosure
intervention, and promote best intervention practices in mortgage
servicing programs for consumers at risk of foreclosure who could
qualify for alternate financing.
Working with our federal and state regulatory counterparts, insured
institutions, the Congress, and other parties, we are eager to help
find solutions for borrowers who have mortgages they cannot afford.
Supervising Financial Institutions
The FDIC is responsible, along with the other federal banking agencies
and state regulators, for monitoring insured institutions that may have
exposure to troubled mortgages or related assets. Recently, exposures
have manifested in the form of liquidity and funding issues for a small
group of institutions that are significantly involved in mortgage
banking activities. For the largest institutions whose actions can have
a significant impact on the marketplace itself, the FDIC is working
with each institution's primary federal regulator to monitor their on-
and off-balance sheet activities. The FDIC has stepped up its offsite
monitoring of other institutions with potential mortgage pipeline
exposures and in some cases have made unscheduled visits to ascertain
the effect of the current market interruption on their liquidity and
capital. In the longer term, a significant downturn in the housing
market may lead to asset quality deterioration for a larger number of
institutions with heavy exposures to single-family construction loans
as well as nontraditional and subprime mortgages. The vast majority of
insured institutions are well positioned by virtue of their strong
capital to deal with adverse conditions. Experience suggests that
credit quality problems arising from economic conditions tend to play
out over time. FDIC examination processes are well-suited to deal with
these types of problems should they develop. The FDIC and our fellow
regulators will remain vigilant as credit conditions change.
It also is important that financial institution supervisors do all they
can do to improve consumer protection and make certain that rules for
all market participants are consistent. The uncertainty that now
pervades the marketplace -- which is in many respects attributable to
underwriting practices that were sometimes speculative, predatory, or
abusive -- has seriously disrupted the functioning of the
securitization market and the availability of mortgage credit. In light
of the credit quality problems that have already arisen and may yet
emerge from MBS, investor appetite for all but high-quality,
agency-conforming mortgages has been significantly reduced. Restoring
the proper functioning of essential capital market processes requires
that regulators better define and enforce the principles of sound
underwriting for mortgage loans for all mortgage lenders, not just
FDIC-insured institutions.
The Board of Governors of the Federal Reserve System (FRB) has recently
solicited public comment on how to utilize its rulemaking authority
under the Home Ownership and Equity Protection Act of 1994 (HOEPA) to
prevent predatory lending practices. We encourage the FRB to exercise
its authority to set strong national standards for all lenders that
will eliminate abusive, unfair, or deceptive lending practices and
consumer information, which have contributed to deterioration and
uncertainty in our financial markets. The FRB's authority to reach all
mortgage loan originators through a rulemaking under HOEPA gives it an
exceptional opportunity to impose uniform and fair rules that protect
consumers in their transactions with all mortgage loan originators,
while maintaining a level playing field for banks, non-banks, and
mortgage brokers.
The shakeout in the mortgage market also holds lessons for processes
that rely on modeling to determine appropriate capital levels. A purely
historic look at mortgage loan data would have suggested much lower
capital levels under the advanced approaches of Basel II. Capital
requirements generated under these assumptions would likely have been
insufficient given the poor performance experienced in many of the
nontraditional mortgage products in the marketplace. More broadly, it
will be no less difficult to fully understand the risks in more complex
and dynamic products, such as collateralized debt obligations, credit
derivatives and leveraged lending. Some products and markets could pose
risks and stresses that prove impossible to quantify. Banks and
supervisors can attempt to build an appropriate level of stress into
the advanced capital calculations of Basel II, but the lag in
identifying and understanding changes in market practices may make this
very difficult. Recent events have clearly demonstrated that it is
essential that institutions maintain strong capital levels during the
implementation of Basel II.
Conclusion
Poor, and in some cases predatory, underwriting in recent years has led
to two serious consequences. First, it has created financial distress
for many households. Second, it has disrupted broader credit markets
that rely on the securitization process. While the resulting loss of
credit capacity is expected to be temporary, it is important that
during this period the banking industry is well-positioned to supply
credit, especially for home mortgages. We must take additional steps to
ensure that our financial system treats borrowers fairly and allows
investors to have confidence in the underwriting that supports complex
financial instruments. We look forward to working with this Committee
to address the many issues raised by recent market developments. This
concludes my statement. I will be happy to answer any questions the
Committee might have.
Comments