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
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.
