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Wednesday, October 12, 2005

Fed Governor Bies on Regulatory Responses to Credit Risk and Discrimination in Mortgage Markets

Continuing the remarks by Fed officials from Greenspan and Kohn, Federal Reserve Governor Susan Bies also discusses monetary policy, particularly regulation.

Governor Bies discusses the Fed's regulatory response to increases in credit risk in mortgage and commercial real estate markets, recent proposals to change capital rules (I cut most of this so if you are interested, you may want to read the original document), and the topic of fair lending as examined through data obtained through the recent Home Mortgage Disclosure Act:

Regulatory Issues, by Fed Governor Susan Schmidt Bies: ...Today, I would like to focus on three regulatory issues that are currently high on the list of both bankers and supervisors: credit risk, particularly in residential and commercial real estate; the proposed revisions to the current minimum regulatory capital requirements; and the new disclosures under the Home Mortgage Disclosure Act (HMDA).

First, I would like to talk about credit risk, which has been the leading cause of bank failures over the years and remains the biggest risk for most financial institutions. While credit performance has been very strong lately, and banks of all sizes survived the 2001 recession with only a slight decline in credit quality, banking supervisors have become concerned recently about apparent increased risk-taking in both commercial and residential real estate lending. .... The federal agencies issued joint guidance on home equity lines of credit, or HELOCs, in May; we are now working on additional guidance on affordability products in the residential mortgage market and on underwriting practices in the commercial real estate market. Residential real estate lending has been a significant focus of supervisory attention this year. Average U.S. housing prices have appreciated more than 80 percent since 1997... Home prices react fundamentally to factors affecting affordability, such as household income growth and mortgage interest rates. But another factor apparently fueling price appreciation has been an increase in speculative buying...As home prices have risen, lenders have turned to a variety of ways to help their customers buy the homes they want. ... Non-traditional, or "affordability," mortgage products are designed to minimize down-payments, initial monthly payments, or both. ... From the point of view of bank supervisors, affordability products do not necessarily pose solvency concerns. Despite the apparent decline in underwriting standards, less than 5 percent of outstanding mortgages have a loan-to-value ratio greater than 90 percent, which means that the vast majority of homeowners have a significant equity cushion; in the event prices fall... Still, affordability products pose special risks ... The bank regulators are conducting a survey of industry practices with respect to affordability products and are considering guidance on the subject in the near future. We hope to find out whether financial institutions are fully assessing and managing the new risks posed by affordability products...

I would now like to discuss a few recent developments pertaining to regulatory capital. As most of you probably know, ... Last week, the four federal bank regulatory agencies--the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Office of Thrift Supervision--decided to publish an interagency advance notice of proposed rulemaking (ANPR) for revisions to the existing risk-based capital rules. All four agencies are looking forward to comments from the industry and others on the proposal. ... Bankers--particularly at small-to-medium-sized institutions--have expressed concerns about our work on regulatory capital rules because of the potential competitive implications ... As we move forward with revisions ..., we continue to be quite interested in the comments of bankers and others about the potential implications of these proposals...

The topic of fair lending, seen through the prism of the new Home Mortgage Disclosure Act data on mortgage loan pricing, is easily worth a speech in itself. Today, I will only be able to touch on the topic. However, you will be hearing more from the Federal Reserve about these data as we conduct further analysis. The data ... raise as many questions as they answer. ... As you have seen in recent headlines, the data show that African-American and Hispanic borrowers obtain higher-priced mortgage loans much more frequently than do whites or Asian-Americans. For example, African-American borrowers obtained higher-priced conventional home purchase loans in 2004 more than three-and-one-half times as often as white borrowers; Hispanics, more than twice as often as whites. Such great disparities raise legal issues of compliance with fair lending laws as well as basic ethical, social, and economic questions. Attempting to answer those questions would be well beyond the scope of my remarks today. I will simply emphasize that disparities of this kind challenge us to understand them better. ... Th[e] partial explanation for the differences in the incidence of higher-priced borrowing, however, begs for its own explanation: Why is there a racial and ethnic difference in the tendency of borrowers to obtain loans from lenders that concentrate on higher-priced lending? Qualitative and quantitative research on such questions will be critical to understanding racial and ethnic differences in lending outcomes. Staff at the Federal Reserve will continue their research, and we hope and expect others will join them...

    Posted by on Wednesday, October 12, 2005 at 10:46 AM in Economics, Fed Speeches, Housing, Monetary Policy, Regulation | Permalink  TrackBack (0)  Comments (6)

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