by Gary North
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 bubble.
He admitted that the present economic slowdown was heavily dependent on the fall in the real estate market: about one percentage point.
Of 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 base.
Developments 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.
Homebuilders 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.
Subprime 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 resets.
In short, the fat lady has not yet sung. But, no problem!
We 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.
Whatever 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.
In 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?
Broadly 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!
Of 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.
Next 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 ones.
We 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.
Together 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.
There now. Don't you feel confident about the future? There will be lots more of the same. That will fix everything.
June 7, 2007
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