Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Recent Events in the Credit and Mortgage Markets
And
Possible Implications for U.S. Consumers and the Global Economy
before the
Financial Services Committee, U.S. House of Representatives
2128 Rayburn House Office Building
September 5, 2007
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.
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
On
Recent Events in the Credit and Mortgage Markets
And
Possible Implications for U.S. Consumers and the Global Economy
before the
Financial Services Committee, U.S. House of Representatives
2128 Rayburn House Office Building
September 5, 2007
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
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