Federal Reserve Chairman Ben Bernanke said Friday that the housing finance system being constructed following the collapse of the current system will need better safeguards to allow it to function during times of stress.
Whatever shape the new system takes should ensure that the institutions that support the financing of home mortgages do not pose a systemic risk to our financial markets and the economy, Bernanke said in a speech prepared for a housing conference in Berkeley, Calif.
He outlined a number of possible ways to structure housing finance in the future, but did not state his own preferences.
The issue of how financing should be restructured was a good one for policymakers to address during what he called the current “time out” when Fannie Mae and Freddie Mac are both under the control of the federal government, Bernanke said.
The two mortgage giants were placed into conservatorship on Sept. 7, part of a series of events that have unfolded as the biggest financial crisis in seven decades has hit the U.S. economy.
Speaking about the credit crisis that started in August 2007, Bernanke said it began with the end of a prolonged housing boom in the U.S. that exposed “serious deficiencies in the underwriting and credit rating” for mortgages, particularly subprime mortgages, loans made to borrowers with weak credit histories.
Banks and thrifts are still making new mortgage loans during the current credit squeeze but have tightened terms considerably, “essentially closing the private market to borrowers with weaker credit histories,” Bernanke said.
But he said the credit problems went far beyond housing.
“The boom in subprime mortgage lending was only part of a much broader credit boom characterized by underpricing of risk, excessive leverage and the creation of complex and opaque financial instruments that proved fragile under stress,” he said. “The unwinding of these developments is the source of the severe financial strain and tight credit that now damp economic growth.”
He did not make any predictions on when the credit crisis will end or discuss the overall economy more broadly. On Wednesday, the Fed cut the federal funds rate, the interest that banks charge each other, by a half-point to 1 percent, which ties the lowest level seen in the past half century.
While the Fed held out the prospect of further rate cuts to keep the economy out of a severe recession, Bernanke did not address that issue Friday.
He did say that private companies have basically stopped all of their activities to purchase mortgages and collect them into large pools to be sold as securities, something now only being done by Fannie, Freddie and Ginnie Mae. By contrast, private companies accounted for half of the market for mortgage-backed securities in 2005 at the height of the housing boom.
“That experience suggests that, at least under the most stressed conditions, some form of government backstop may be necessary to ensure continued securitization of mortgages,” Bernanke said.
Bernanke laid out various options that policymakers could consider for overhauling housing finance, from keeping Fannie and Freddie under government control permanently, to breaking up the two giants into smaller organizations that would be privately owned.
Bernanke did not rank the various options he explored, but said that policymakers must design a new system that would meet the goal of providing adequate financing for home mortgages while ensuring the safety of the entire financial system.
“Regardless of organizational form, we must strive to design a housing system that ensures the successful funding and securitization of mortgages during times of financial stress but that does not create institutions that pose systemic risks to our financial markets and the economy,” he said.