Summary of Bernake speach last August 31st

Mortgage and Lending with Mortgage Solutions Financial

The actual speech is long, but worth the it not only addresses the current mortgage and financial market crisis ,but provides a good summary of the history of USA mortgage finance.  Here is a summary:

Bernanke clearly and unambiguously acknowledges that there has been a financial panic that has gone way beyond the underlying (deteriorating mortgage credit) fundamentals when he said, "Although this episode appears to have been triggered largely by heightened concerns about subprime mortgages, global financial losses have far exceeded even the most pessimistic projections of credit losses in those loans."


I thought the "history of mortgage finance" section is a very worthwhile read. It clearly shows that mortgage finance...albeit with a lot of "fits, failures, and starts" has become significantly better for consumers and the economy over time.


In particular the section entitled: "The Emergence of Capital Markets as a Source of Housing Finance"....describes the circumstances that allowed entities like Indymac Bank to become successful. Here are a few important excerpts:


"The manifest problems associated with relying on short-term deposits to fund long-term mortgage lending set in train major changes in financial markets and financial instruments, which collectively served to link mortgage lending more closely with the broader capital markets. The shift from reliance on specialized portfolio lenders financed by deposits to a greater use of capital markets represented the second great sea change in mortgage finance, equaled in importance only by the events of the New Deal."


"Critically, the savings and loan crisis of the late 1980s ended the dominance of deposit-taking portfolio lenders in the mortgage market. By the 1990s, increased reliance on securitization led to a greater separation between mortgage lending and mortgage investing even as the mortgage and capital markets became more closely integrated. About 56 percent of the home mortgage market is now securitized, compared with only 10% in 1980 and less than 1% in 1970."


"In some ways, the new mortgage market came to look more like a textbook financial market, with fewer institutional "frictions" to impede trading and pricing of event-contingent securities. Securitization and the development of deep and liquid derivatives markets eased the spreading and trading of risk. New types of mortgage products were created. Recent developments notwithstanding, mortgages became more liquid instruments, for both lenders and borrowers."


"The traditional model of mortgage markets, based on portfolio lending, solved these problems in a straightforward way: Because banks and thrifts kept the loans they made on their own books, they had a strong incentive to underwrite carefully and to invest in gathering information about borrowers and communities. In contrast, when most loans are securitized and originators have little financial or reputational capital at risk, the danger exists that originators of loans will be less diligent."


"In securitization markets, therefore, monitoring the originators and ensuring that they have incentives to make good loans is critical. I have argued elsewhere that, in some cases, the failure of investors to provide adequate oversight of originators and to ensure that originators' incentives were properly aligned was a major cause of the problems that we see today in the subprime mortgage market."


"We will not return to the days in which all mortgage lending was portfolio lending, but clearly the originate-to-distribute model will be modified---is already being modified---to provide stronger protection for investors and better incentives for originators to underwrite prudently."


NOTE: The above comments from the Fed Chairman align perfectly to my quote in our last IR presentation that "investors are the control point, not the lenders in a securitization marketplace" and to my memo to the senior management team on August 21st,  entitled "Breaking away from Wall Street"....where I describe going directly to investors with underwriting guidelines and "aligning interests better" guaranteeing we will retain the non-investment grade and residual securities for a year or more.


Lastly, two other comments I though deserve highlighting:


There has been a lot of negativity of late associated with home equity is what the Fed Chairman said about home equity lending:


"Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability..."


So, home equity lending not only allows someone to send their daughter to college...but also helps stabilize the economy.


I am sure that as a result of well over a decade of strong and stable housing....many believed that housing had become much less cyclical....clearly it has not. I will end with a quote from the Fed Chairman on this topic:


"That said, the current episode demonstrates that pronounced housing cycles are not a thing of the past."