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Bernanke: Housing Slump, Subprime Collapse Will Slow Growth

By Martin H. Bosworth
ConsumerAffairs.com

July 18, 2007

"The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards and the recent increase in mortgage interest rates," Bernanke said in a report to the House Financial Services Committee today.

"[E]ven if demand stabilizes as we expect, the pace of construction will probably fall somewhat further as builders work down stocks of unsold new homes," Bernanke said. "Thus, declines in residential construction will likely continue to weigh on economic growth over coming quarters, although the magnitude of the drag on growth should diminish over time."

Bernanke reiterated that growth would continue thanks to strong labor markets, and that the Fed's prime worry continued to be inflation, but he was more blunt than ever in describing the extent of the damage done by the "subprime meltdown.

"For the most part, financial markets have remained supportive of economic growth," he said. "However, conditions in the subprime mortgage sector have deteriorated significantly, reflecting mounting delinquency rates on adjustable-rate loans."

Although Bernanke said at the outset of his testimony that consumer protection issues were "not normally addressed in monetary policy testimony," he devoted much of his time to discussing the subprime market failures and how the Federal Reserve was addressing the issue, including revising mortgage lending disclosures as part of the Truth In Lending Act (TILA).

"By the end of the year, we will propose changes to TILA rules to address concerns about mortgage loan advertisements and solicitations that may be incomplete or misleading and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them," he said.

Bernanke also outlined the creation of a multilayered oversight program to more stringently review and police subprime lenders, in cooperation with the FTC and the Office of Thrift Supervision, as well as state regulators.

Congress has criticized the Federal Reserve for not providing enough oversight of fraudulent lending practices in the subprime sector and not responding quickly enough when the market began to collapse.

Homeowners who bought homes using subprime "creative" loans were often not adequately prepared for the "rate shock" when their mortgages suddenly increased.

As home prices began to fall across the country due to excessive inventory, homeowners who tried to sell or refinance to get out of their bad loans found themselves trapped.

The end result has been record levels of foreclosure across the country, as well as the implosion of many subprime lenders into bankruptcy or bailouts by hedge funds such as Bear Stearns.

Financial Services Committee chair Barney Frank recently called for legislation that would mandate liability for bad loans to be shared by mortgage bond investors. Bernanke himself cautioned against a Federal-level bailout for bad lenders in his testimony, saying that "we don't want to reward lenders for making bad loans."

In a speech made March 30, Bernanke also admitted that enabling increased access to credit in order to spur the housing boom may have encouraged unscrupulous lenders to push subprime mortgages to first-time buyers who may not have been financially ready to own a home -- or might have qualified for better loans.

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