Bernanke Rules

Is The Fed under Chairman Ben Bernanke  finally beginning to adopt the tougher lending regulations and rules that would’ve prevented much of the havoc of the last two years?  In a speech on April 17, Bernanke stated that damage done to the economy was not likely to be undone any time soon.  This gives more credence to the idea that we may see an L-shaped recovery.  In other words, be prepared to scuttle across the bottom for a very long time. But did the speech deliver the assurances we need that necessary steps and regulations w lending practices and financial innovations are in the works?  I don’t think so.

Here’s some interesting analysis by Craig Torres at Bloomberg.com.

Federal Reserve Chairman Ben S. Bernanke said the collapse of U.S. lending will probably cause “long-lasting” damage to home prices, household wealth and borrowers’ good credit score.

“One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be,” the Fed chairman said today in a speech at the central bank’s community affairs conference in Washington. “The damage from this turn in the credit cycle — in terms of lost wealth, lost homes, and blemished credit histories — is likely to be long-lasting.”

The U.S. central bank has cut the benchmark lending rate to as low as zero and taken unprecedented steps to stem the credit crisis through direct support of consumer finance and mortgage lending. The Fed plans to purchase as much as $1.25 trillion in agency mortgage-backed securities this year to support the housing market and is providing financing for securities backed by loans to consumers and small businesses.

Bernanke and the Federal Reserve Board approved rules last July to toughen restrictions on mortgages, banning high-cost loans to borrowers with no verified income or assets and curbing penalties for repaying a loan early. The action came after members of Congress and other regulators urged the Fed to use its authority to prevent abusive lending.

This suggests Bernanke does not see home values going back up any time soon.  It also suggests that the lending markets are not likely to return to their heyday.  Does this mean, however, that we’re finally going to see the regulation and enforcement of prudent underwriting standards and no more hide the trash in a bundle and pass it to the next sucker?

“We should not attempt to impose restrictions on credit providers so onerous that they prevent the development of new products and services in the future,” Bernanke said. Regulations should ensure “innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes.”

I think I need a Guide to Bernanke Speak for that one.  I’m hoping that means we get some standardarization of process and contract in the CDS markets, but what exactly is ‘onerous’?  Hopefully, it’s not the same nonstandard of  Bubbles Greenspan.  Also, how can we assure that low income families can still have access to the mortgage market when they are deserving and that they will be protected from aggressive mortgage brokers looking for bonuses?  Afterall, subprime mortgages are still creating defaults and problems in many parts of the country.

Subprime mortgage delinquencies stood at 22 percent in the fourth quarter compared to 5 percent for loans to the highest- rated or “prime” borrowers, according to the Mortgage Bankers Association.

“Something went wrong,” Bernanke said. “We have come almost full circle with credit availability increasingly restricted for low- and moderate-income borrowers.”

Not only are the most vulnerable likely to be the hardest hit in the housing market, they are also likely to be the ones vulnerable to the ongoing deterioration in the jobs market.

The recession that began in December 2007 has come at a high cost to American employment and wealth.

Unemployment rose to 8.5 percent in March, the highest since 1983. U.S. home prices fell 8.2 percent in 2008, according to the Federal Housing Finance Agency. Household net worth fell $11.2 trillion in 2008, according to Fed data.

U.S. homeownership rates fell to 67.5 percent in the fourth quarter of 2008 from 68.9 percent in the same quarter of 2006, according to U.S. Census Bureau data. Black homeownership rates have fallen to 46.8 percent from 48.2 percent in the same period, and Hispanic homeownership stood at 48.6 versus 49.5 percent.

Mortgage delinquencies in the fourth quarter increased to a seasonally adjusted 7.88 percent of all loans, the highest in records going back to 1972, according to the Mortgage Bankers Association. Loans in foreclosure rose to 3.30 percent, also an all-time high.

Ryan Avent of Conde Nast’s Porfolio had this to say about Bernanke’s April 17th speech.

Bernanke focused on consumer-oriented innovations rather than obscure structured financial products, which should have made the defense of recent financial innovation a little easier. No dice. According to Bernanke, no one, “wants to go back to the 1970s,” but neither could Bernanke point to a truly helpful piece of financial innovation developed after that decade. His examples of successful financial products? Credit cards, for one, which date from the 1950s. Policies facilitating the flow of credit to lower income borrowers was another, for which he credited the Community Reinvestment Act of 1977. And, of course, securitization and the secondary mortgage markets developed by Fannie Mae and Freddie Mac in…the 1970s.

So, Bernanke was basically charged with creating new regulations for some of the more opaque and puzzling financial innovations (read credit derivatives)  and he goes after subprime lending.   From Avent:

The Fed chairman either has no desire to prevent a wave of new and tight regulations from constraining financial institutions, or he is completely and utterly tone deaf.

At the moment, the public is not at all inclined to believe that financial wizardry has positively contributed to economic growth or social welfare. I can’t imagine how Bernanke thinks he’s going to convince them otherwise using speeches like this.

During the entire speech, there was one reference to the vast deregulation of the 1990s that allowed for the development of instruments like CDOs and CDSs (Credit Default Obligations, Credit Default Swaps).  But again, Bernanke returns to poor underwriting processes and loan originations rather than the credit instruments themselves.

[I]n the early 1990s, automated underwriting systems helped open new opportunities for underserved consumers to obtain traditional forms of mortgage credit. This innovation was followed by an expansion of lending to borrowers perceived to have high credit risk, which became known as the subprime market. Lenders developed new techniques for using credit information to determine underwriting standards, set interest rates, and manage their risks. As I have already mentioned, the ongoing growth and development of the secondary mortgage market reinforced the effect of these innovations, giving mortgage lenders greater access to the capital markets, lowering transaction costs, and spreading risk more broadly. Subprime lending rose dramatically from 5 percent of total mortgage originations in 1994 to about 20 percent in 2005 and 2006.

The loan origination process is only one side of the problem.  The other side is the nonstandard contract and delivery process in many credit derivatives.  They are also less transparent because no regulator audits and polices them.  Maybe Bernanke decided to go after the lending side of the market first because it’s definitely part of the Fed’s charter and is clearly part of the Truth in Lending Laws.  (That would be the loan originators like WAMU).  However, this does not address the folks bundling the stuff in a nice little set of ribboned packages,  the folks rating the stuff as AAA, and the folks writing the contracts to insure the contents.  (Those would be the folks like Goldman Sachs).  Perhaps he’s waiting for legislation.  Perhaps he thinks it’s something the SEC should be doing.  I just hope it’s something benign like that but after the last few years, I’m not placing any bets.