Bernanke: Free Market Can Curb Foreclosures
In
remarks he made yesterday in Chicago, Federal Reserve Board Chairman Ben S. Bernanke talked extensively about how he believes the Federal Reserve Board should respond to
rising foreclosures — specifically in the subprime mortgage market.
His conclusion came down in favor of the free market:
"Credit market innovations have expanded opportunities for many households. Markets can overshoot, but, ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit."
His conclusion echoes the conclusion this blog came to back in January in a post titled
Defaults Drive Subprime Lending Restraint. We cited the story of one subprime lender that was tightening its lending guidelines because of purely market forces — namely it was losing a lot of money because of the high default rate of some of its loans.
Bernanke did not rule out using the powers at the government's disposal — disclosure requirements, rules, guidance combined with supervisory oversight, and informal collaboration with the industry — to prevent "fraud and abusive lending and to ensure that lenders employ sound underwriting practices." But he cautioned that such government intervention should not "inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers."
Of the four options available, Bernanke touted "effective disclosures" as the best "first line of defense against improper lending." He said the Federal Reserve can impact disclosure requirements through its writing of the regulation implementing the Truth in Lending Act (TILA). Bernanke conceded that implementing rules, which the Home Ownership Equity Protection Act (HOEPA) gives the Federal Reserve the authority to do, may be necessary in some cases as long as the rules are "drawn sharply, with bright lines and address practices that are never, or almost never, legitimate." Less black-and-white practices are more appropriately regulated through supervisory guidance, which the Federal Reserve can draft but only applies to banks and thrift institutions — which are not the institutions most directly affected by the recent subprime shakeout.
Bernanke was not overly optimistic about the near-term future of the housing market, pinpointing the "cooling of the housing market" as a major contributor to the economy's slowdown in 2006. And he predicted "further increases in delinquencies and foreclosures this year and the next as many adjustable-rate loans face interest-rate resets." Still, he ended on a positive note:
"All that said, given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market 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."