Ben Bernanke's Post-Horse Barn Door-Locking Strategy for Real Estate

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Ben Bernanke’s
June 5, 2007 speech
on the real estate market
was an exercise in futility.

He did not
refer to the obvious: his predecessor’s monetary policy, which created
a real estate bubble. Instead, he promised new regulatory measures,
which are in fact the old measures, which failed to prevent the

He admitted
that the present economic slowdown was heavily dependent on the
fall in the real estate market: about one percentage point.

course, the adjustment in the housing sector is still ongoing, and
the slowdown in residential construction now appears likely to remain
a drag on economic growth for somewhat longer than previously expected.
Thus far, however, we have not seen major spillovers from housing
onto other sectors of the economy. On average, over coming quarters,
we expect the economy to advance at a moderate pace, close to or
slightly below the economy’s trend rate of expansion.

As expected,
we have also seen a gradual ebbing of core inflation, although
its level remains somewhat elevated. . . . However, although core
inflation seems likely to moderate gradually over time, the risks
to this forecast remain to the upside. In particular, the continuing
high rate of resource utilization suggests that the level of final
demand may still be high relative to the underlying productive
capacity of the economy.

But what is
causing this price inflation? He did not say. That’s because price
inflation is a monetary phenomenon, and the FED controls the monetary

in the Housing Market

As you know,
the downturn in the housing market has been sharp. From their
peaks in mid-2005, sales of existing homes have declined more
than 10 percent, and sales of new homes have fallen by 30 percent.
A leveling-off of sales late last year hinted at a possible stabilization
of housing demand; however, once one smoothes through the monthly
volatility of the data, more-recent readings indicate that demand
weakened further, on net, over the first four months of this year.
House prices decelerated sharply last year, following annual gains
averaging 9 percent from 2000 to 2005. Prices have continued to
be quite soft so far in 2007, although for the most part outright
price declines have been concentrated in markets that showed especially
large increases in earlier years.

have responded to weak sales by curtailing construction. Single-family
housing starts have declined by a third since early 2006, sufficient
to subtract about 1 percentage point from real GDP growth over
the past four quarters. Despite the drop in homebuilding, the
inventory of unsold new homes has risen to more than seven months
of sales, a level well above the average observed over the past
decade. Accordingly, and as reflected in the continued downward
trend in permits to build single-family homes, residential construction
will likely remain subdued for a time, until further progress
can be made in working down the backlog of unsold new homes.

In short, there
is no sign that the housing downturn has ended.

Then there
is the sub-prime lending market — the market that seemed risk-free
to the boneheads who got rich making the loans, which was in fact
a disaster waiting to happen.

Recent developments
in the subprime mortgage market add somewhat to the usual uncertainty
in forecasting housing demand. Subprime mortgage borrowing nearly
tripled during the housing boom years of 2004 and 2005. But decelerating
house prices, higher interest rates, and slower economic growth
have contributed to an increased rate of delinquency among subprime
borrowers. This increase has occurred almost entirely among borrowers
with adjustable-rate mortgages; delinquency rates for fixed-rate
subprime mortgages have remained generally stable. . . . As a
consequence of these developments, investors are now scrutinizing
nonprime loans more carefully, and lenders in turn have tightened
up their underwriting. Risk premiums on indexes of credit default
swaps for subprime mortgage-backed securities (MBS) began to widen
sharply late last year, especially for those on pools of mortgages
originated in 2006.

In short, the
lenders were idiots. They did not see this coming. The experts were
lured in by Mr. Greenspan’s bubble policies.

and near-prime mortgage originations rose sharply in 2004 and 2005
and likely accounted for a large share of the increase in the number
of home sales over that period. However, originations of nonprime
mortgages to purchase homes appear to have peaked in late 2005 and
declined substantially since then, and by more (even in absolute
terms) than prime mortgage originations. Thus, some part of the
effect on housing demand of the retrenchment in the subprime market
has likely already been felt. . . . the tightening of terms and
standards now in train may well lead to some further contraction
in nonprime originations in the period ahead. We are also likely
to see further increases in delinquencies and foreclosures this
year and next as many subprime adjustable-rate loans face interest-rate

In short, the
fat lady has not yet sung. But, no problem!

will follow developments in the subprime market closely. However,
fundamental factors — including solid growth in incomes and
relatively low mortgage rates — should ultimately support the
demand for housing, and at this point, the troubles in the subprime
sector seem unlikely to seriously spill over to the broader economy
or the financial system.

Then he added
a long section on “Federal Reserve Initiatives and Possible Regulatory
Actions.” In short, the horse is out of the barn, so it’s time for
barn door-locking measures.

What we need
is nice guy bankers — sweethearts who don’t foreclose on people
who will be voting in 2008.

their effects on the broader economy, the problems in the subprime
sector are causing real distress for many homeowners. To help mitigate
the situation, the Federal Reserve and other federal supervisory
agencies are encouraging the banks and thrift institutions that
we supervise to work with borrowers who may be having trouble meeting
their mortgage obligations, including identifying and contacting
borrowers before they enter delinquency or foreclosure. Federal
Reserve Banks around the country are cooperating with community
and industry groups that work with borrowers and affected communities.
We also continue to work with organizations that provide counseling
about mortgage products to current and potential homeowners.

These people
can’t pay. Bankers should try not to foreclose. It’s water under
the bridge. Bygones are bygones. In short, don’t foreclose.

addition, we at the Federal Reserve, other regulators, and the Congress
are evaluating what actions may be needed to prevent a recurrence
of these problems. In deciding, we must walk a fine line: We have
an obligation to prevent fraud and abusive lending; at the same
time, we must tread carefully so as not to suppress responsible
lending or eliminate refinancing opportunities for subprime borrowers.

In short, they
don’t know what to do, but they plan on doing it, Real Soon Now.

He reminded
us that the Feds have 4 tools to protect consumers. Really? Then
why did they fail to prevent the current state of affairs?

speaking, financial regulators have four types of tools to protect
consumers and to promote safe and sound underwriting practices:
required disclosures by lenders, rules to prohibit abusive or deceptive
practices, principles-based guidance with supervisory oversight,
and less-formal efforts to work with industry participants to promote
best practices. The Federal Reserve currently is conducting a thorough
review of its policies with respect to each of these instruments.

What should
the Federal Reserve do now? Why, what it does so well. It should
publish reports!

course, the information provided by even the best-designed disclosures
can be useful only when it is well understood. Accordingly, the
Federal Reserve produces a range of consumer education materials,
including information to help potential borrowers understand adjustable-rate
and other alternative mortgages, and we actively promote financial
education by partnering with outside organizations.

Not only that,
the FED will hold public hearings. Yes, my friends, public hearings.

week we are holding a public hearing to gather input about potential
abuses in mortgage lending. We will also continue to seek input
from consumer and industry groups, the Federal Reserve’s Consumer
Advisory Council, our fellow regulators, and others who may have
useful insights about mortgage lending practices.

There will
be guidelines. The old ones didn’t work well, so there will be new
have also used, and will continue to use, supervisory guidance to
help mitigate problems in nonprime lending. Last year, together
with other federal banking regulators, we issued guidance concerning
so-called nontraditional mortgages. We have also issued draft supervisory
guidance concerning underwriting standards and disclosures for subprime
mortgages. The agencies are now reviewing the many responses to
the draft proposal.

What we need
is more regulation. There must be more centralization.

The patchwork
nature of enforcement authority in subprime lending poses a special
challenge. For example, rules issued by the Board under HOEPA
apply to all lenders but are enforced — depending on the
lender — by the Federal Trade Commission, state regulators,
or one of the five federal regulators of depository institutions.
To achieve uniform and effective enforcement, cooperation and
coordination are essential. We are committed to working closely
with other federal and state regulators to ensure that the laws
that protect consumers are enforced.

with other regulators and the Congress, we have much to do and
many issues to consider. We undertake that effort with utmost
seriousness because our collective success will have significant
implications for the financial well-being, access to credit, and
opportunities for homeownership of many of our fellow citizens.

now. Don’t you feel confident about the future? There will be lots
more of the same
. That will fix everything.

7, 2007

North [send him mail] is the
author of Mises
on Money
. Visit
He is also the author of a free 19-volume series, An
Economic Commentary on the Bible

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