April 30, 2008 Quotes of the Day - Thomas Jefferson

Honesty is the first chapter in the book of wisdom.   Thomas Jefferson

In matters of style, swim with the current; in matters of principle, stand like a rock.   Thomas Jefferson

Information is the currency of democracy.   Thomas Jefferson

I do not take a single newspaper, nor read one a month, and I feel myself infinitely the happier for it.   Thomas Jefferson

I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.   Thomas Jefferson

I like the dreams of the future better than the history of the past.   Thomas Jefferson

A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor and bread it has earned - this is the sum of good government.   Thomas Jefferson

For a people who are free, and who mean to remain so, a well-organized and armed militia is their best security.   Thomas Jefferson

Advertisements contain the only truths to be relied on in a newspaper.   Thomas Jefferson

I sincerely believe that banking establishments are more dangerous than standing armies, and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.   Thomas Jefferson

Commerce with all nations, alliance with none, should be our motto.   Thomas Jefferson

Educate and inform the whole mass of the people... They are the only sure reliance for the preservation of our liberty.   Thomas Jefferson

Press Release

Release Date: April 30, 2008

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.

2008 Monetary Policy Releases

April 29, 2008 Quotes of the Day by Warren Buffett

If past history was all there was to the game, the richest people would be librarians.   Warren Buffett

In the business world, the rearview mirror is always clearer than the windshield.   Warren Buffett 

It's better to hang out with people better than you. Pick out associates whose behavior is better than yours and you'll drift in that direction. Warren Buffett 

It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Warren Buffett

A public-opinion poll is no substitute for thought.   Warren Buffett

Chains of habit are too light to be felt until they are too heavy to be broken.   Warren Buffett

Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.   Warren Buffett

The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective.   Warren Buffett

Price is what you pay. Value is what you get.   Warren Buffett

 

Bush to focus on economy at news conference

President to urge Congress to pass new ‘sensible’ bills, spokeswoman says

WASHINGTON - President Bush will address Americans’ growing worry about the economy at a news conference Tuesday at the White House.

Spokeswoman Dana Perino said the president would deliver an opening statement on the “understandable anxiety” about issues affecting their pocketbooks.

The president will "call upon Congress to send him sensible and effective bills that will help Americans weather this difficult period and keep our country moving forward," she said.

April 28, 2008 Quotes of the Day - Winston Churchill

A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.   Winston Churchill

A politician needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year. And to have the ability afterwards to explain why it didn't happen.  Winston Churchill                                                                                   

All the great things are simple, and many can be expressed in a single word: freedom, justice, honor, duty, mercy, hope.   Winston Churchill 

Attitude is a little thing that makes a big difference.   Winston Churchill

Continuous effort - not strength or intelligence - is the key to unlocking our potential.   Winston Churchill                   

Courage is rightly esteemed the first of human qualities... because it is the quality which guarantees all others.   Winston Churchill

Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen.   Winston Churchill

Criticism may not be agreeable, but it is necessary. It fulfils the same function as pain in the human body. It calls attention to an unhealthy state of things.   Winston Churchill

Difficulties mastered are opportunities won.   Winston Churchill

April 27, 2008 Quotes of the Day-Aristotle

Excellence is an art won by training and habituation. We do not act rightly because we have virtue or excellence, but we rather have those because we have acted rightly. We are what we repeatedly do. Excellence, then, is not an act but a habit. Aristotle
                                                                                                                                                       Friendship is a single soul dwelling in two bodies. Aristotle
                                                                                                                                                                       I count him braver who overcomes his desires than him who conquers his enemies; for the hardest victory is over self. Aristotle

The wise man does not expose himself needlessly to danger, since there are few things for which he cares sufficiently; but he is willing, in great crises, to give even his life - knowing that under certain conditions it is not worthwhile to live. Aristotle

Courage is the first of human qualities because it is the quality which guarantees the others. Aristotle
                                                                                                                                                                    At his best, man is the noblest of all animals; separated from law and justice he is the worst. Aristotle

Bring your desires down to your present means. Increase them only when your increased means permit. Aristotle

Character may almost be called the most effective means of persuasion. Aristotle
                                                                                                                                                            Dignity consists not in possessing honors, but in the consciousness that we deserve them. Aristotle

April 26, 2008 Quotes of the Day-Henry Wadsworth Longfellow 

The talent of success is nothing more than doing what you can do well, and doing well whatever you do without thought of fame. If it comes at all it will come because it is deserved, not because it is sought after.   Henry Wadsworth Longfellow 

A single conversation across the table with a wise man is better than ten years mere study of books.   Henry Wadsworth Longfellow

Ambition is so powerful a passion in the human breast, that however high we reach we are never satisfied.   Henry Wadsworth Longfellow

Morality without religion is only a kind of dead reckoning - an endeavor to find our place on a cloudy sea by measuring the distance we have run, but without any observation of the heavenly bodies.   Henry Wadsworth Longfellow

Most people would succeed in small things if they were not troubled with great ambitions.   Henry Wadsworth Longfellow

Ships that pass in the night, and speak each other in passing, only a signal shown, and a distant voice in the darkness; So on the ocean of life, we pass and speak one another, only a look and a voice, then darkness again and a silence.   Henry Wadsworth Longfellow
                                                                                                                                                     Sometimes we may learn more from a man's errors, than from his virtues.   Henry Wadsworth Longfellow

They who go Feel not the pain of parting; it is they Who stay behind that suffer.   Henry Wadsworth Longfellow

We judge ourselves by what we feel capable of doing, while others judge us by what we have already done.   Henry Wadsworth Longfellow

7 Reasons to Own Your Home
                                                                                                                                                                    1. Tax breaks. The U.S. Tax Code lets you deduct the interest you pay on your mortgage, your property taxes, as well as some of the costs involved in buying your home.

2. Appreciation. Real estate has long-term, stable growth in value. While year-to-year fluctuations are normal, median existing-home sale prices have increased on average 6.5 percent each year from 1972 through 2005, and increased 88.5 percent over the last 10 years, according to the NATIONAL ASSOCIATION OF REALTORS®. In addition, the number of U.S. households is expected to rise 15 percent over the next decade, creating continued high demand for housing.

3. Equity. Money paid for rent is money that you’ll never see again, but mortgage payments let you build equity ownership interest in your home.

4. Savings. Building equity in your home is a ready-made savings plan. And when you sell, you can generally take up to $250,000 ($500,000 for a married couple) as gain without owing any federal income tax.

5. Predictability. Unlike rent, your fixed-mortgage payments don’t rise over the years so your housing costs may actually decline as you own the home longer. However, keep in mind that property taxes and insurance costs will increase.

6. Freedom. The home is yours. You can decorate any way you want and benefit from your investment for as long as you own the home.

7. Stability. Remaining in one neighborhood for several years gives you a chance to participate in community activities, lets you and your family establish lasting friendships, and offers your children the benefit of educational continuity.

Questions to Ask When Choosing a REALTOR®
                                                                                                                                                                Make sure you choose a REALTOR® who will provide top-notch service and meet your unique needs.

1. How long have you been in residential real estate sales? Is it your full-time job? While experience is no guarantee of skill, real estate — like many other professions — is mostly learned on the job.

2. What designations do you hold? Designations such as GRI and CRS® — which require that agents take additional, specialized real estate training — are held by only about one-quarter of real estate practitioners.

3. How many homes did you and your real estate brokerage sell last year? By asking this question, you’ll get a good idea of how much experience the practitioner has.

4. How many days did it take you to sell the average home? How did that compare to the overall market?
The REALTOR® you interview should have these facts on hand, and be able to present market statistics from the local MLS to provide a comparison.

5. How close to the initial asking prices of the homes you sold were the final sale prices? This is one indication of how skilled the REALTOR® is at pricing homes and marketing to suitable buyers. Of course, other factors also may be at play, including an exceptionally hot or cool real estate market.

6. What types of specific marketing systems and approaches will you use to sell my home? You don’t want someone who’s going to put a For Sale sign in the yard and hope for the best. Look for someone who has aggressive and innovative approaches, and knows how to market your property competitively on the Internet. Buyers today want information fast, so it’s important that your REALTOR® is responsive.

7. Will you represent me exclusively, or will you represent both the buyer and the seller in the transaction? While it’s usually legal to represent both parties in a transaction, it’s important to understand where the practitioner’s obligations lie. Your REALTOR® should explain his or her agency relationship to you and describe the rights of each party.

8. Can you recommend service providers who can help me obtain a mortgage, make home repairs, and help with other things I need done? Because REALTORS® are immersed in the industry, they’re wonderful resources as you seek lenders, home improvement companies, and other home service providers. Practitioners should generally recommend more than one provider and let you know if they have any special relationship with or receive compensation from any of the providers.

9. What type of support and supervision does your brokerage office provide to you? Having resources such as in-house support staff, access to a real estate attorney, and assistance with technology can help an agent sell your home.

10. What’s your business philosophy? While there’s no right answer to this question, the response will help you assess what’s important to the agent and determine how closely the agent’s goals and yours are.

Need a REALTORS® and don't know where to begin - try www.askaboutrealestate.net and make your request for a TOP Real Estate Professional.

Why You Should Work With a REALTOR®

Not all real estate practitioners are REALTORS®. The term REALTOR® is a registered trademark that identifies a real estate professional who is a member of the NATIONAL ASSOCIATION of REALTORS® and subscribes to its strict Code of Ethics. Here are five reasons why it pays to work with a REALTOR®.

1. You’ll have an expert to guide you through the process. Buying or selling a home usually requires disclosure forms, inspection reports, mortgage documents, insurance policies, deeds, and multi-page settlement statements. A knowledgeable expert will help you prepare the best deal, and avoid delays or costly mistakes.

2. Get objective information and opinions. REALTORS® can provide local community information on utilities, zoning, schools, and more. They’ll also be able to provide objective information about each property. A professional will be able to help you answer these two important questions: Will the property provide the environment I want for a home or investment? Second, will the property have resale value when I am ready to sell?

3. Find the best property out there. Sometimes the property you are seeking is available but not actively advertised in the market, and it will take some investigation by your REALTOR® to find all available properties.

4. Benefit from their negotiating experience. There are many negotiating factors, including but not limited to price, financing, terms, date of possession, and inclusion or exclusion of repairs, furnishings, or equipment. In addition, the purchase agreement should provide a period of time for you to complete appropriate inspections and investigations of the property before you are bound to complete the purchase. Your agent can advise you as to which investigations and inspections are recommended or required.

5. Property marketing power. Real estate doesn’t sell due to advertising alone. In fact, a large share of real estate sales comes as the result of a practitioner’s contacts through previous clients, referrals, friends, and family. When a property is marketed with the help of a REALTOR®, you do not have to allow strangers into your home. Your REALTOR® will generally prescreen and accompany qualified prospects through your property.

6. Real estate has its own language. If you don’t know a CMA from a PUD, you can understand why it’s important to work with a professional who is immersed in the industry and knows the real estate language.

7. REALTORS® have done it before. Most people buy and sell only a few homes in a lifetime, usually with quite a few years in between each purchase. And even if you’ve done it before, laws and regulations change. REALTORS®, on the other hand, handle hundreds of real estate transactions over the course of their career. Having an expert on your side is critical.

8. Buying and selling is emotional. A home often symbolizes family, rest, and security — it’s not just four walls and a roof. Because of this, home buying and selling can be an emotional undertaking. And for most people, a home is the biggest purchase they’ll ever make. Having a concerned, but objective, third party helps you stay focused on both the emotional and financial issues most important to you.

9. Ethical treatment. Every member of the NATIONAL ASSOCIATION of REALTORS® makes a commitment to adhere to a strict Code of Ethics, which is based on professionalism and protection of the public. As a customer of a REALTOR®, you can expect honest and ethical treatment in all transaction-related matters. It is mandatory for REALTORS® to take the Code of Ethics orientation and they are also required to complete a refresher course every four years.

5 Common First-Time Home Buyer Mistakes

1. They don’t ask enough questions of their lender and end up missing out on the best deal.

2. They don’t act quickly enough to make a decision and someone else buys the house.

3. They don’t find the right agent who’s willing to help them through the homebuying process.

4. They don’t do enough to make their offer look appealing to a seller.

5. They don’t think about resale before they buy. The average first-time buyer only stays in a home for four years.

Comments - let us know what you think!

10 Ways to Prepare for Homeownership

1. Decide what you can afford. Generally, you can afford a home equal in value to between two and three times your gross income.

2. Develop your home wish list. Then, prioritize the features on your list.

3. Select where you want to live. Compile a list of three or four neighborhoods you’d like to live in, taking into account items such as schools, recreational facilities, area expansion plans, and safety.

4. Start saving. Do you have enough money saved to qualify for a mortgage and cover your down payment? Ideally, you should have 20 percent of the purchase price saved as a down payment. Also, don’t forget to factor in closing costs. Closing costs — including taxes, attorney’s fee, and transfer fees — average between 2 and 7 percent of the home price.

5. Get your credit in order. Obtain a copy of your credit report to make sure it is accurate and to correct any errors immediately. A credit report provides a history of your credit, bad debts, and any late payments.

6. Determine your mortgage qualifications. How large of mortgage do you qualify for? Also, explore different loan options — such as 30-year or 15-year fixed mortgages or ARMs — and decide what’s best for you.

7. Get preapproved. Organize all the documentation a lender will need to preapprove you for a loan. You might need W-2 forms, copies of at least one pay stub, account numbers, and copies of two to four months of bank or credit union statements.

8. Weigh other sources of help with a down payment. Do you qualify for any special mortgage or down payment assistance programs? Check with your state and local government on down payment assistance programs for first-time buyers. Or, if you have an IRA account, you can use the money you’ve saved to buy your fist home without paying a penalty for early withdrawal.

9. Calculate the costs of homeownership. This should include property taxes, insurance, maintenance and utilities, and association fees, if applicable.

10. Contact a REALTOR®. Find an experienced REALTOR® who can help guide you through the process. 

Request a Top Real Estate Professional at www.askaboutrealestate.net.

Comments - Lets hear them!

April 25, 2008 Quotes of the Day - Abraham Lincoln
 
America will never be destroyed from the outside. If we falter and lose our freedoms, it will be because we destroyed ourselves.
Abraham Lincoln
 
And in the end it's not the years in your life that count. It's the life in your years.
Abraham Lincoln
                                                                                                                                                                 The probability that we may fail in the struggle ought not to deter us from the support of a cause we believe to be just.
Abraham Lincoln
                                                                                                                                                                With Malice toward none, with charity for all, with firmness in the right, as God gives us to see the right, let us strive on to finish the work we are in, to bind up the nation's wounds.
Abraham Lincoln

With public sentiment, nothing can fail. Without it, nothing can succeed.
Abraham Lincoln

You cannot build character and courage by taking away a man's initiative and independence.
Abraham Lincoln

You cannot escape the responsibility of tomorrow by evading it today.
Abraham Lincoln
                                                                                                                                                                 You cannot help men permanently by doing for them what they could and should do for themselves.
Abraham Lincoln

You have to do your own growing no matter how tall your grandfather was.
Abraham Lincoln

Don't interfere with anything in the Constitution. That must be maintained, for it is the only safeguard of our liberties.
Abraham Lincoln 

Don't worry when you are not recognized, but strive to be worthy of recognition.
Abraham Lincoln

Better to remain silent and be thought a fool than to speak out and remove all doubt.
Abraham Lincoln

Comments on the quotes of the day?  Let us know what you are thinking!

30-Year Rates Jump to 6.03%

Freddie Mac reports a jump in the 30-year fixed mortgage rate to 6.03 percent during the week ended April 24, from 5.88 percent the prior week, marking the first time in six weeks that mortgage rates rose above 6 percent.

The 15-year fixed mortgage rate climbed during the same period, edging up to 5.62 percent from 5.40 percent.

The five-year adjustable mortgage rate increased to 5.68 percent from 5.48 percent, while the one-year adjustable rate shot up to 5.28 percent from 5.10 percent.

Freddie Mac chief economist Frank Nothaft attributes the gains to heightened inflationary concerns.

Source: Baltimore Sun (04/25/08)

Comments on this article?  What do you think - sound off and let us know your thoughts!

Mortgage Brokers Get Jail Time for Scam
Two mortgage brokers and a title attorney have been sentenced to multiple years in prison for their parts in a $37 million mortgage scam.

America’s Best Mortgage Services broker Richard Crowder got 11 years for luring buyers to a fraudulent no-money-down financing scheme to purchase 17 condos complexes called Continuum and Point of Aventura, both on Miami Beach.

His accomplices, title attorney Gary Mills, owner of Four Star Title, and former Wachovia loan officer Karen Lynn Sullivan, got 46 months and 50 months in jail respectively.

Officials charged that Sullivan would draw up phony closing documents showing the would-be buyers already owned the units, then she would help get fraudulent home equity credit lines. The money was used to make down payments on first mortgages for the same units and pay the fees and commissions.

Source: Miami Herald, Monica Hatcher (04/25/08)
Comments - We want to hear from you!  Tell us what you are thinking about this article or any other similar article.

1. Idaho
2. District of Columbia
3. Arizona
4. Tennessee
5. Louisiana
6. Wyoming
7. Vermont
8. Montana
9. Georgia
10. California

1. West Virginia
2. Alabama
3. Delaware
4. Pennsylvania
5. Ohio
6. Connecticut
7. Rhode Island
8. Hawaii
9. Washington
10. Virginia

Among the 15 largest metropolitan areas in the United States, the highest entrepreneurial activity rates were in Phoenix, Riverside-San Bernardino, Atlanta, Los Angeles, and Miami. Philadelphia posted the lowest rate of entrepreneurial activity.

Source: Ewing Marion Kauffman Foundation (04/24/08)

Comments - We want to hear from you!  Tell us what you are thinking about this article or any other similar article.

April 24, 2008 Quotes of the Day - Donald Trump

Experience taught me a few things. One is to listen to your gut, no matter how good something sounds on paper. The second is that you're generally better off sticking with what you know. And the third is that sometimes your best investments are the ones you don't make.
Donald Trump

I don't make deals for the money. I've got enough, much more than I'll ever need. I do it to do it.
Donald Trump

I have made the tough decisions, always with an eye toward the bottom line. Perhaps it's time America was run like a business.
Donald Trump

I like thinking big. If you're going to be thinking anything, you might as well think big.
Donald Trump

1. Miami
2. Orlando
3. Phoenix
4. Tampa
5. Los Angeles
6. Washington, D.C.
7. Chicago
8. Baltimore
9. San Diego
10. Denver

Governor Randall S. Kroszner

At the Community Reinvestment Fund First Annual Forum, Minneapolis, Minnesota

April 21, 2008

Developing Sustainable Capital for Community Investments

Good afternoon. I am pleased to address the inaugural Community Reinvestment Fund (CRF) Annual Community Forum Series. The development of sustainable capital sources through innovation is an important goal for the Community Development Financial Institutions (CDFI) industry. Today's host, CRF, has played a pioneering role in the development of a secondary market for community development loans, a topic I spoke on more than a year and a half ago in Washington, D.C.

The financial markets have experienced much turbulence since that time. The turmoil in the subprime mortgage market, in particular, has affected liquidity of the larger secondary markets. Given the cautious state of financial markets, how can the CDFI industry enhance the attractiveness of CDFI investments to private capital?

The markets have changed, but the core ideas I raised in my previous remarks are more relevant than ever. There is a striking parallel with the challenges for the re-emergence of the subprime mortgage market and the adoption of innovations in the community development investments market. To overcome the unease of the current financial markets and attract a new source of capital, new market entrants must make particular efforts to reduce the uncertainty associated with their investment opportunities. For the CDFI industry, the challenges that need to be addressed are improving information about these products, developing models of risk and pricing, and standardizing these contracts. Addressing these issues will be critical to jump-start sustainable private CDFI investments as well as to revive the subprime mortgage market.

Growth of Community Development Finance and Current Challenges
The Community Reinvestment Act (CRA) was enacted more than 30 years ago in response to deteriorating economic conditions in urban areas, particularly in lower-income and minority communities. The CRA served as a catalyst in attracting innovative public and private investment capital into low- and moderate-income communities. Consider the following: In 1991, 2,000 community development corporations (CDCs) built 300,000 units and 17 million square feet of commercial space. In 2006, 4,600 CDCs built 1.2 million units and 126 million square feet of commercial space. Today, there are more than 600 CDFIs with more than $19 billion in assets and with more than $20 billion of finance activities. The CRF has issued three rated securities within the past six years totaling almost $200 million, opening the door to institutional investors and expanding the marketplace.

The migration toward sustainable mainstream capital sources is important in light of budgetary challenges facing governmental and philanthropic funding sources. For CDFIs to expand the scope and volume of their financing activities, they need to develop new products and innovations that tap more predictable sources of funding. Accessing the broad depth of the capital markets as a self-sustaining funding source for community development would yield enhanced benefits, such as more-efficient delivery of capital, greater funding and underwriting discipline, and reduced finance costs.

Of course, a real challenge is building a bridge between the two very different worlds of capital markets and community development. The former requires strict market discipline, a rich set of data to assess risk and pricing, and standardization. The latter, community development, however, has a commitment to individuals and communities that have been left out of the economic mainstream and uses products tailored to their unique circumstances. These two worlds, however, can be brought together; and that has begun to happen, particularly around the challenges I will discuss in greater detail.

Importance of Data for New Products and Proper Risk Modeling
When a new product is being developed, there is an initial experimentation phase in which market participants learn a great deal about the product's performance and risk characteristics. This phase involves gathering and processing information and modeling the performance of the product in various scenarios and under different market conditions. It may then take time for market participants to understand what, exactly, they need to know to value a product. During the early phases, a fair amount of due diligence is appropriate, given the greater uncertainty associated with innovative products.¹

In the initial experimentation phase, the terms and characteristics of a new product are adjusted in response to market acceptance--or lack thereof. During this period, market participants are seeking and providing information so that they can properly value the product, judge its potential for risk and return, assess its market acceptance and liquidity, and determine the extent to which the risks of the product can be hedged or mitigated.

To do this, market participants must perform due diligence, a process to gather and assess relevant sources of information to evaluate that product. Due diligence is critical because market participants must trust but verify the market-provided information. Potential purchasers, for example, might engage in various activities, ranging from assessing risk exposures through stress testing to assessing the enforceability of contracts that define the requirements of investors, trustees, guarantors, and originators.

We have recently seen how a lack of information and insufficient due diligence have created problems in the market for subprime residential mortgage-backed securities. Many investors appear not to have demanded sufficient information about these investment vehicles, or perhaps did not carefully evaluate the information that was available. Instead, they may have simply accepted or trusted credit ratings as a substitute for their own risk analysis, and not verified enough. As a result, subprime delinquencies and defaults exceeded expectations. Lack of information, a stressed financial environment, and disparate contract obligations led to a general lack of liquidity in the subprime market, which later spread to the broader market for mortgage securities.

Investors in new and innovative products have suffered losses before. In the early 1990s, for example, participants engaged in the collateralized mortgage obligation (CMO) market and in certain types of interest rate derivatives that did not have adequate information about the potential volatility and prepayment risk involved. Consequently, market participants did not appropriately model these risks and suffered significant losses when market interest rates rose sharply in the mid-1990s. As in the case of today's market for residential mortgage-backed securities, the general market reaction was a flight away from these instruments. However, over time, the market was restored as market participants came to better understand the risks and as standardized methods were developed to measure the risks and model the value of these instruments under alternative scenarios. Increased information and standardized pricing conventions, such as the use of option-adjusted spreads, moved these instruments from the experimentation and learning phase to broad market acceptance.

When market participants realize that they do not have the information necessary for proper valuation of risks, market liquidity can become impaired, such as in the CMO market in the 1990s and in the subprime market recently. A significant investment in information gathering, processing, and evaluation may be necessary to revive markets. This process will likely take time. First, more-detailed data will need to be collected in a more systematic manner in order to better understand the nature and risks of the instruments and their underlying assets. Second, investments will need to be made to warehouse and model data related to these instruments, which will enhance the understanding of risks, particularly under stress conditions. Third, investments in human capital expertise--that is, in people so that they can better understand, interpret, and act appropriately on the results of the modeling and analysis of the information gathered--will also need to be made. Finally, sellers may respond by reducing complexity and by improving the quality of the underlying assets, increasing transparency, or both. Ultimately, the payoff from these activities will be a greater understanding of risks and greater ability to value the instruments.

For innovations in the community development investment markets, it will also likely take time for these markets to mature because of the time and cost to systematically collect data and for investors to understand these new instruments. To accelerate the development of these markets, however, some key issues will need to be addressed. First, how will the CDFI industry organize itself to generate and collect this data? Second, who is poised to lead efforts in setting standards for industry data? Finally, who and how will the intellectual capital be developed to model and structure these new instruments? There should also be consideration of existing standards from established products that parallel developing ones, such as the adoption of best practices for both mortgage securitizations and community development securitizations.

I do want to acknowledge that there have been many notable accomplishments in pioneering community development investments. For example, there is a growing secondary market for community development loans; community development venture capital has grown 100 percent since 2002 to more than $800 million in assets under management in 2004; since 2002, the New Markets Tax Credit Program has issued $16 billion in allocations, with a growing sophisticated market for investments and trading of the tax credit equity.

I am pleased that the Federal Reserve Banks have played an active role as a convener on these topics and in the dissemination of best practices and policy. I enjoyed sharing my thoughts on the topic of the development of the secondary markets for community development loans at a forum that was hosted last year by the Board of Governors and the Federal Reserve Banks of San Francisco and New York. For these markets to grow significantly, however, there must be continued dialogue and exchange between market participants to collect these data uniformly from the beginning to the culmination of these deals so that performance data are captured.

Standardization in Developing Markets
These data should be collected with consideration toward improving standardization of many of the aspects of the product, which can help to increase transparency, improve efficiency, and reduce uncertainty. For example, the recovery of the CMO market was aided by improved information and modeling, which increased confidence, especially as products became increasingly standardized. Standardization in the terms and in the contractual rights and obligations of purchasers and sellers of the product reduces, but does not eliminate, the need for market participants to engage in extensive efforts to obtain information and reduces the need to verify the information that is provided in the market through due diligence. Reduced information costs, in turn, lower transaction costs, thereby facilitating price discovery and enhancing market liquidity. Also, standardization can reduce legal risks because litigation over contract terms can result in case law that applies to similar situations, thus reducing uncertainty.

The benefits of the development of standardization for enhancing the liquidity of financial markets have a long history. One particularly clear example dates back to the development of exchange-traded commodities futures contracts in the mid-1800s. The standardization of the futures markets improved the flow of information to market participants, reducing transaction costs and fostering the emergence of liquid markets.²

In the mid-1850s, the market for grain did not enjoy the very deep liquidity we see in today's market. At the time, Chicago was facing competition from exchanges in Minneapolis and St. Louis and from some in Europe that had created innovative structures to make markets more liquid. To create a liquid market for grain trading, buyers and sellers of grain needed a way of systematically analyzing the different kinds of grain that came into the exchange from different sources. In other words, the market needed a way to "grade the grain." The market created special silos that combined grain from a number of sources. Buyers no longer bought a silo of grain from one source; a silo, for example, of "Winter Wheat Number 2" would be graded in a way that allowed buyers to know exactly what they were getting.

Standardization and related controls reduced traders' information requirements and, thus, their transaction costs. The Board of Trade established minimum quality standards based on the need for market participants to evaluate the reliability of promises of future deliveries of grain to the buyer. In 1865, the Chicago Board of Trade standardized the delivery dates for the contracts, thus fostering the emergence of liquid markets in which traders could readily hedge the risk of price changes in the commodities and contracts. Buyers and sellers of grain ultimately became members of the exchange, supported by an underpinning of standardized measures of grain quality and minimum standards for exchange members.

This example of how standardization helped jump-start a marketplace may provide insights regarding the current challenges in the subprime markets as well as the development of the community development investment market. As of January 2008, the most recent month for which data are available, about 24 percent of subprime adjustable-rate mortgages (ARMs) were 90 or more days delinquent, twice the level one year earlier.³ Roughly 190,000 foreclosures were started on these mortgages in the fourth quarter, up 11 percent from the previous quarter.⁴ The cost of foreclosures is high for lenders, investors, communities and causes severe disruption and distress to individuals and families. With the continuing high rates of foreclosure and the high costs associated with foreclosures, it is in the interest of lenders, investors, and borrowers to develop prudent loan modification programs to help borrowers on a larger scale and at sustainable levels.

Efforts to streamline or standardize the loan modification process could lower transaction costs, provide timely relief for distressed borrowers, and reduce uncertainties in the market for subprime mortgage-backed securities. Industry and consumer groups are exploring loan modification templates, clarification of accounting rules, automated electronic platforms, and standards to streamline the loan modification process. The Hope Now Alliance--a broad-based coalition of government-sponsored enterprises, industry trade associations, counseling agencies, and mortgage servicers--is making efforts to find ways to help borrowers through loan modification plans.

The Board has also sought to ensure clear lending standards through stricter regulations prohibiting abusive and deceptive practices in the mortgage market under the authority of the Home Ownership and Equity Protection Act (HOEPA). This proposal is intended to protect consumers and to preserve consumer choice by targeting protections to borrowers who face the most risk. Under HOEPA, the Board is considering changes that would stem abusive practices by addressing the following: a requirement to assess repayment ability, a requirement to escrow taxes and insurance, a ban on prepayment penalties in certain circumstances, a prohibition on a lender paying a broker more than the consumer had expressly agreed that the broker would receive, and a ban on specific advertising practices deemed unfair or deceptive. Clarifying lending standards will increase investor confidence in the mortgage market and help to revive the flow of credit to consumers, particularly those with shorter or weaker credit histories.

These lessons learned from standardization challenges facing the subprime market may be helpful as the community development industry considers ways to reduce uncertainty to enhance the attractiveness of CDFI investments. The wide variety of investment activities of the CDFI industry is a formidable challenge to standardization. The industry encompasses rental housing and commercial real estate and small business finance and has disparate origination channels that range from small non-profit intermediaries to large financial institutions.

A more recent development in the over-the-counter markets may be informative. Over-the-counter derivative products are multifaceted and designed to be customized to the unique needs of market participants. To standardize these products, while maintaining their unique features, the International Swaps and Derivatives Association created a master agreement that not only provided standard definitions and a general outline for the contract, but also provided latitude to include customized terms. The master agreement also sets forth a template for workout procedures if a counterparty defaults, allowing parties to adjust risk-management strategies based on the work-out arrangements. Ultimately, the standardization provided by the master agreement reduces uncertainty about the instruments, lowers transaction costs, and facilitates price discovery and market liquidity.

Similarly, the community development investments field may consider the benefits of standardizing some type of master agreement that captures key structural provisions and that incorporates the flexibility to include customized terms of the underlying transactions. I would also encourage the CDFI industry to explore the possibility of some type of organized marketplace for its investments, whether it is an online platform or an added component of an existing marketplace, or some other similar initiative.

Conclusion
To achieve a more dynamic marketplace for community development investments, the CDFI industry should continue to dialogue and to strengthen bridges with mainstream financial market participants. To reduce uncertainty around community development investments, the CDFI industry must collect and provide uniform data so that appropriate risk and pricing models can be developed and must also make efforts to standardize these contracts. Conversely, capital providers must strengthen working relationships with the CDFI industry to develop a richer understanding of the finance activities and unique risks and strengths of these investment opportunities. As these two seemingly disparate worlds of the capital markets and the community development industry address these challenges together, a powerful source of sustainable private capital can be tapped to fund an equally powerful spectrum of community investments. I am confident that the expertise and dedication found in the community development industry can move the industry in the right direction to address these obstacles as well as to expand the flow of capital to low- and moderate-income communities and individuals.

Footnotes

1. Randall S. Kroszner (2007), "Innovation, Information, and Regulation in Financial Markets," speech delivered at the Philadelphia Fed Policy Forum, Philadelphia, November 30. Return to text

2. Randall S. Kroszner (1999), "Can the Financial Markets Privately Regulate Risk? The Development of Derivatives Clearing Houses and Recent Over-the-Counter Innovations,"  Journal of Money, Credit, and Banking, vol. 31 (August), p. 600. Return to text

3. Board staff calculation based on data from First American LoanPerformance. Return to text

4. Board staff calculation based on data from the Mortgage Bankers Association. Return to text

Scott G. Alvarez, General Counsel 

Sovereign wealth funds

Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate

April 24, 2008

Chairman Dodd, Senator Shelby, and members of the Committee, I am pleased to appear today to provide the Committee with information on the regulatory framework that applies to investments by sovereign wealth funds in U.S. banks and bank holding companies.  The Board commends the Committee for holding this hearing and for considering the important public policy issues raised by these investments.

As requested, I intend to focus my testimony on the recent sovereign wealth fund investments in U.S. financial institutions and their financial implications, the regulations applicable to investments by these funds in U.S. banking organizations and in foreign banking organizations with U.S. banking operations, and the tools available to the federal banking agencies to ensure that these investments comply with U.S. law.  I will begin with some general information about sovereign wealth funds and U.S. banking organizations and a summary of recent investments by sovereign wealth funds in U.S. banks and bank holding companies.  Then I will describe the relevant U.S. banking laws applicable to investments by sovereign wealth funds in banks and bank holding companies and the treatment under those laws of these funds by the Federal Reserve.

Sovereign Wealth Funds
Broadly speaking, a sovereign wealth fund is an investment fund that is owned by a national or state government.  Globally, there are about 30 to 40 sovereign wealth funds at this time. Many sovereign wealth funds were originally set up to help stabilize revenues from the sale of a commodity, such as oil, natural gas or other commodities.  They also provide a way to preserve and grow wealth for future generations.  Chile, Botswana and Kiribati have established sovereign wealth funds based on their revenues from the sales of copper, diamonds, and phosphate.  Examples of governments that have established funds using oil revenues include Norway, Kuwait, Qatar, and the state of Alaska.

Some developed nations have established sovereign wealth funds using social security or government pension fund surpluses and contributions from taxes and other government revenues.  These types of funds invest in a wide range of domestic and foreign assets with the aim of supplementing the financing of social security or government pension programs.  Countries with this type of fund include France, Australia, and New Zealand.  Other sovereign wealth funds have been established to make profitable use of foreign exchange accumulated as the result of trade imbalances or foreign exchange intervention.  Countries with this type of fund include Singapore, Korea, and China.

To achieve their objective of preserving and growing wealth for future generations or of profiting from often temporary surpluses of foreign exchange, sovereign wealth funds--like any investment fund--seek to earn an appropriate risk-adjusted return on the funds that they invest.  Sovereign wealth funds apply many of the same kinds of strategies that other investment funds apply.  Some funds, such as Norway's, engage solely in making small portfolio investments--i.e., their equity investments are typically below 10 percent of the voting shares of a firm.  Others, such as Singapore's Temasek Holdings (Temasek), take substantial stakes in firms in selected domestic and foreign industries.

One of the reasons that sovereign wealth funds have attracted more attention in the past year is their size.  The largest funds are very large.  For example, Norway's sovereign wealth fund reports total assets of over $350 billion; China's fund and Singapore's two funds each manage assets of at least $100 billion.  This places sovereign wealth funds among the largest investment funds worldwide.  However, while the estimated $2 to $3 trillion sovereign wealth funds manage exceeds the $1.4 trillion managed by hedge funds, it is much less than the over $15 trillion managed by pension funds, the $16 trillion managed by insurance companies, or the $21 trillion managed by investment companies.¹  It is an even smaller fraction of global debt and equity securities, which exceed $100 trillion.

Another factor that has made sovereign wealth funds stand out in recent years has been their rapid growth.  Estimates suggest that sovereign wealth funds have been growing at a remarkable pace in recent years, possibly quadrupling in size between 2003 and 2007.  This rapid growth arises from the growth in revenues from the sale of oil and other commodities, following significant increases in commodities prices.  It also arises from the rapid accumulation of foreign exchange reserves and persistent current account imbalances.

A third reason that sovereign wealth funds have attracted attention in the United States recently has been their investments in U.S. financial institutions, which is what I will talk about today.

Investments of Sovereign Wealth Funds in U.S. Financial Services Companies
The U.S. banking system is being challenged by current market conditions.  Insured commercial banks have experienced deterioration in asset quality and earnings, much attributable to the effect of the slowing residential housing market on the quality of residential mortgage and construction loans.  Fortunately, banks encountered these conditions after a sustained period of strong earnings and capital accumulation that strengthened the financial condition of the industry, and should reduce potential threats to their solvency from current market conditions.  Several large U.S. banking organizations have also recently raised new capital.  That capital has come from a broad range of sources, including public offerings, private investors, private and public equity firms and sovereign wealth funds.  The ability of U.S. financial institutions to raise large amounts of capital from a diverse domestic and international investor base under stress conditions evidences market confidence in the transparency and ultimate resiliency of these institutions.  The Federal Reserve has welcomed and encouraged capital raising initiatives that buttress the financial strength of U.S. financial institutions and better positions these institutions to weather the current financial turmoil. 

Since August 2007, U.S. banking organizations have raised approximately $100 billion in new capital.  During this period, sovereign wealth funds have been an important source of capital for U.S. financial institutions.  Sovereign wealth funds made direct investments totaling more than $30 billion in U.S. financial firms, including approximately $17 billion in commercial banking organizations.   

The recent wave of sovereign wealth fund investments in U.S. financial institutions consists of noncontrolling investments below 10 percent (and often below 5 percent) of voting equity.  For example, Citigroup recently received a capital infusion from the Kuwait Investment Authority (KIA), the Abu Dhabi Investment Authority (ADIA), and the Government of Singapore Investment Corporation (GIC), one of Singapore's two sovereign investment funds.  None of these funds acquired more than 5 percent of Citigroup's total equity.  Three sovereign wealth funds, the Korea Investment Corporation (KIC), Temasek, and KIA, each made similar noncontrolling investments in convertible preferred stock in Merrill Lynch and Co.  These are all passive investments that have not triggered formal review under U.S. banking law, as I will explain in a moment.  The press releases from the financial institutions announcing each of these recent investments have generally emphasized that these sovereign investors will not seek to exercise control over the target company and will not have representation on the target company's board of directors or take part in its management. 

Thresholds for Federal Reserve Review
As a general matter, the same statutory and regulatory thresholds for review by the federal banking agencies apply to investments by sovereign wealth funds as apply to investments by other domestic and foreign investors in U.S. banks and bank holding companies.  These requirements are established in two federal statutes, the Bank Holding Company Act (BHC Act) and the Change in Bank Control Act (CIBC Act).²  The BHC Act requires any company to obtain approval from the Federal Reserve before making a direct or indirect investment in a U.S. bank or bank holding company if the investment meets certain thresholds.  In particular, the BHC Act requires Board review when a company acquires: (1) ownership or control of 25 percent or more of any class of voting securities of the bank or bank holding company, (2) control of the election of a majority of the board of directors of the bank or bank holding company, or (3) the ability to exercise a controlling influence over the management or policies of the bank or bank holding company.

A formal determination that a company exercises a controlling influence over the management or policies of a bank or bank holding company may only be made after the Board has provided notice to the company and offered an opportunity for a hearing.  In determining whether an investor may exercise a controlling influence over the management or policies of a U.S. bank or bank holding company for purposes of the BHC Act, the Board considers the size of the investment, the involvement of the investor in the management of the bank or bank holding company, any business relationships between the investor and the bank or bank holding company, and other relevant factors indicating an intent or ability to significantly influence the management or operations of the bank or bank holding company.  The BHC Act presumes that an investor that controls less than 5 percent of the voting shares of a U.S. bank or bank holding company does not have a controlling influence over that bank or bank holding company, and the Board generally has not found that a controlling influence exists if the investment represents less than 10 percent of the bank or bank holding company's voting shares. 

A company that meets any of these thresholds is called a "bank holding company" and, in addition to the prior approval process, is subject by statute to supervision by the Federal Reserve, including examination, reporting, and capital requirements, as well as to the Act's restrictions on the mixing of banking and commerce.  Moreover, a company that makes an investment that causes it to be a bank holding company is subject to a prior review requirement at a lower threshold for any investments in additional banks or bank holding companies.  If a company already controls one U.S. bank, the company is required by statute to obtain approval from the Federal Reserve prior to acquiring more than 5 percent of the voting shares of another U.S. bank or bank holding company.

There is one additional requirement governing the applicability of the BHC Act that is noteworthy.  The BHC Act applies only to investments in banks and bank holding companies that are made by "companies."  The definition of "company" in the Act specifies a number of types of entities that fall within the definition, including corporations, partnerships, and trusts.  However, the definition of a company does not reference governments.  On this basis, the Board has long held that the provisions of the BHC Act do not apply to direct investments made by the U.S. government or by any state or foreign government. 

The BHC Act specifically excludes from its coverage a corporation controlled by the United States or by a state government.  Thus, investment companies controlled by the states of Alaska and New Jersey, for example, are specifically excluded from the requirements of the BHC Act.  The exclusion does not, on its face, apply to companies controlled by foreign governments and, as I will discuss in more detail below, the Board has not extended this exclusion to companies controlled by foreign governments that make investments in U.S. banks and bank holding companies.  Foreign governments to date have primarily invested through sovereign wealth funds that are companies controlled by the foreign government.  The effect of the Board's long-standing interpretation is that a sovereign wealth fund that seeks to make an investment in a U.S. bank or bank holding company that exceeds the thresholds in the BHC Act would be required to obtain Board approval prior to making the investment and would become subject to the other provisions of the BHC Act, but its parent foreign government would not.

Investments by sovereign wealth funds that do not trigger the requirements of the BHC Act may nevertheless require approval from a federal banking agency under the CIBC Act.  Prior approval from the Federal Reserve under the CIBC Act generally is required for any acquisition of 10 percent or more of any class of voting securities of a state member bank or bank holding company.  Unlike the BHC Act, which imposes ongoing restrictions on the nonbanking activities of corporate owners of banks as well as ongoing reporting, examination, capital, and other requirements, the CIBC Act does not impose any activity limitations or any ongoing supervisory requirements on owners of banks. 

When an investor applies for the prior approval of the Federal Reserve to make an investment in a bank or bank holding company that triggers the review thresholds under the BHC Act or the CIBC Act, the Federal Reserve evaluates the application under the statutory requirements of those Acts.  The BHC Act mandates that the Federal Reserve consider a number of factors when acting on BHC Act applications, including competitive, supervisory, financial and managerial factors (the last includes consideration of the competence, experience, and integrity of the officers, directors, and principal shareholders of the company or bank).  The CIBC Act also requires the federal banking agency to consider specific factors, including competitive and informational standards as well as whether the transaction would jeopardize the financial stability of the bank, prejudice the interests of the depositors of the bank, or result in an adverse effect on the Deposit Insurance Fund.

Most sovereign wealth funds, like many other investors including U.S. investment banking firms, hedge funds, and private equity pools, have structured their investments so as not to trigger the thresholds for review and approval under either the BHC Act or the CIBC Act.  Instead, sovereign wealth funds have limited their investments to amounts that represent less than 10 percent of the voting shares of the banking organization and have designed their investments to be passive and without the connections or relationships that might allow the sovereign wealth funds to control the U.S. banking organization.    

Investments of Sovereign Wealth Funds in Foreign Banking Organizations
Several sovereign wealth funds, including some that have attracted attention with their recent investments in U.S. financial institutions, also have interests in foreign banks with U.S. operations.  The levels of ownership range from well below 10 percent to, in some cases, interests that indicate control of the foreign bank.  These foreign banks generally conduct their U.S. banking operations through direct offices--branches and agencies; none controlled by a sovereign wealth fund currently controls a U.S. bank subsidiary.  U.S. branches and agencies of foreign banks do not have all of the powers of U.S. bank branches.  Specifically, U.S. branches of foreign banks are not permitted to accept retail deposits (i.e., deposits less than $100,000), except for a small number of grandfathered cases.  Agencies operated by foreign banks cannot accept deposits from citizens or residents of the United States.  Sovereign wealth funds with interests in foreign banks that operate U.S. branches and agencies include Temasek, GIC, China Investment Corporation (CIC), Central Huijin Investment Company (Huijin),³ KIA, and ADIA. 

After 1991, the International Banking Act (IBA) provided that any foreign bank seeking to establish a U.S. branch or agency must apply to the Federal Reserve for prior approval.  All foreign banks controlled by sovereign wealth funds that have U.S. branches or agencies established those branches or agencies before the IBA was amended in 1991 to require Federal Reserve approval of the establishment by foreign banks of new U.S. branches and agencies.⁴  Any future applications by foreign banks controlled by sovereign wealth funds to establish U.S. branches and agencies would be evaluated by the Federal Reserve pursuant to the standards in the IBA.  An important factor the Federal Reserve is required to consider under the IBA is whether the foreign bank is supervised on a comprehensive consolidated basis by its home country supervisor.  The Federal Reserve also examines how the supervisor monitors relationships and transactions between the foreign bank and any related party, including controlling sovereign wealth funds and other controlling shareholders.  A number of additional factors are also considered, including the anti-money laundering regime of the foreign bank and its supervisor, the consent of the appropriate home country authorities, the financial and managerial resources of the foreign bank, and whether the foreign bank and any controlling company (including any controlling sovereign wealth fund) have made adequate assurances concerning provision of information to the Federal Reserve about its operations and activities.  

The Federal Reserve's Approach to Foreign Government Ownership
As I noted above, the Federal Reserve has drawn a distinction between foreign governments themselves, which are not treated as "companies" subject to the BHC Act, and government-owned entities such as sovereign wealth funds, which are treated as companies and are subject to the BHC Act. 

The position that the BHC Act does not apply to foreign governments themselves is long held by the Board.⁵  It noted this view and revisited the reasons for this position in 1982 in connection with an application by an Italian government-owned bank to acquire a controlling interest in a U.S. bank.⁶  At that time, the Board reiterated its view that the BHC Act should not be applied to the Italian government.  At the same time, the Board noted that significant policy issues were raised by foreign government ownership of a U.S. bank, including in particular issues related to the mixing of banking and commerce and to interstate banking in the United States (which was largely prohibited at the time).  The Board invited Congress to address the issue and noted that the concept of national treatment could justify applying the BHC Act to foreign government-owned entities.⁷ 

In 1988, an Italian bank controlled by the Italian government again applied to the Federal Reserve to acquire a U.S. bank.  The Board carefully considered the applicability of the BHC Act to foreign governments and foreign government-owned entities and reiterated its earlier conclusion that, as a legal matter, foreign governments were not themselves "companies" for purposes of the BHC Act and were therefore not covered by the Act.  The Board found, however, that the investment fund controlled by the Italian Government, the Istituto per la Ricostruzione Industriale (IRI), was structured as a corporate vehicle and was therefore a company under the Act and subject to the Act.⁸ 

At the same time, the Board indicated its willingness to grant exemptions from the nonbanking restrictions in the BHC Act to IRI for its commercial investments, citing IRI's status as a nonoperating instrumentality for holding government interests.  The Board also expressed its willingness to apply exemptions available under the BHC Act to the nonbanking investments of other foreign government-owned companies of a character similar to that of IRI, as long as their foreign bank subsidiaries conducted banking in the United States only through branches and agencies and not through U.S. subsidiary banks.  This approach limited the extraterritorial effects of U.S. economic regulation on foreign companies in recognition of the fact that foreign countries may choose to organize their economies differently from the United States.  It also kept the United States open to a significant number of foreign banking organizations whose U.S. banking activities might otherwise have been severely curtailed.  Notwithstanding the availability of this exemption for government-owned companies (including sovereign wealth funds) that control foreign banks with U.S. banking operations, the U.S. operations of foreign banks controlled by government-owned companies are subject to the same degree of U.S. regulation and supervision as the U.S. operations of other foreign banks. 

Regulation of Bank Holding Companies
Since a sovereign wealth fund is a company for purposes of the BHC Act, if a fund were to acquire control of a U.S. bank or bank holding company, it would be treated as a bank holding company and would be subject to the U.S. regulatory regime applicable to such companies.  If a foreign bank that is owned by a sovereign wealth fund were to acquire control of a U.S. bank, that foreign bank would also be subject to the regulatory regime applicable to other bank holding companies.  This regime is designed in significant part to help ensure the safety and soundness of U.S. bank subsidiaries of bank holding companies.  Under the BHC Act, the Board has broad authority to prevent bank holding companies from engaging in unsafe or unsound practices.  As part of the regulatory and supervisory process, the Board may examine bank holding companies and their subsidiaries where necessary or appropriate to protect the U.S. bank affiliates and has the authority to require periodic and annual reporting in many areas, including on ownership, risk management and financial condition.  

Among the most important tools that U.S. bank regulators have to protect the safety and soundness of U.S. banks are the legal restrictions that limit the ability of a bank to lend to affiliates.  Section 23A of the Federal Reserve Act provides that a bank may not lend more than 10 percent of its capital to any one affiliate or more than 20 percent of its capital to all affiliates combined.  Of equal importance, any loan to an affiliate must be either fully collateralized by cash or U.S. Treasury securities or overcollateralized by other assets in an amount of 10 to 30 percent, depending on the type of asset or instrument used to secure the loan.  Section 23A also prohibits the purchase of low-quality assets by a U.S. bank from its affiliates.  Section 23B of the Federal Reserve Act requires that all transactions between a bank and its affiliates be conducted only on an arms-length basis.  These restrictions are designed to limit the ability of an owner of a bank to exploit the bank for the benefit of the rest of the organization.

With respect to a U.S. bank or bank holding company that might be owned by a sovereign wealth fund, these restrictions on transactions with affiliates would apply to transactions by the bank with the sovereign wealth fund itself as well as to transactions with companies controlled by the sovereign wealth fund.  Moreover, the restrictions would apply to companies controlled by the same government through other sovereign wealth funds of that government.  Thus, a U.S. bank controlled by a sovereign wealth fund would not be permitted to fund substantially the operations of other companies controlled by the same sovereign wealth fund or its government owner, or provide any uncollateralized loans to such companies, or purchase low-quality assets from those companies.  In this regard, it would be important for any U.S. bank that might come to be controlled by a sovereign wealth fund to have information on which companies are controlled by the fund and by the government that owns the fund.  This type of transparency would be necessary to allow the bank to comply with the affiliate transaction restrictions of sections 23A and 23B.

Conclusion
Sovereign wealth funds have recently made significant investments in U.S. financial institutions, thereby improving the capital position of these firms and demonstrating confidence in the viability of these U.S. firms.  These investments have also attracted much attention and there is no doubt that sovereign wealth funds are growing in size and number and are making increasingly significant investments in financial services organizations worldwide.  But foreign government-owned entities, including sovereign wealth funds, have owned foreign banks with U.S. operations for many years.  The Board has long taken the position that while foreign governments themselves are not companies subject to the BHC Act, foreign government-owned corporations such as sovereign wealth funds are companies.  Thus any proposed controlling investment in a U.S. bank or bank holding company by a sovereign wealth fund would be subject to Federal Reserve approval.

Sovereign wealth funds, like private investment funds, U.S. state investment vehicles, hedge funds, private equity firms, and many other investors, have generally made investments at levels that are not large enough to trigger the thresholds for review and approval by the federal banking agencies under the federal banking laws.  If a sovereign wealth fund were to make an investment in a U.S. banking organization that triggers one of these thresholds, the application would be evaluated by the Federal Reserve or other appropriate federal banking agency under the relevant statutes with no preference or handicap relative to other investors.  Any sovereign wealth fund controlling a U.S. bank or bank holding company would be required to operate subject to the limitations on affiliate transactions in sections 23A and 23B of the Federal Reserve Act and the bank or bank holding company would be subject to the full range of regulatory and supervisory tools available to the Board.

I appreciate the opportunity to explain these issues to the Committee.

Footnotes

1.   The figures for assets managed by pension funds, insurance companies, and investment companies are for OECD countries only. Return to text

2.   A third federal statute, the Savings and Loan Holding Company Act, governs investments in companies that control savings associations.  The thresholds and standards for review of investments in savings associations established in that act are administered by the Office of Thrift Supervision and are nearly identical to those established by the BHC Act. Return to text

3.   Huijin, a Chinese company with a mandate to improve corporate governance and initiate reforms in the state-owned financial sector, was created to act as a government holding company for Chinese state-owned banks acquired as a result of capital injections by the Chinese government.  Huijin is expected to be acquired by CIC in the near future. Return to text

4.   Huijin acquired its controlling interest in one foreign bank, Bank of China, after the IBA was amended, but also after the establishment of Bank of China’s U.S. branches.  When a company makes a controlling investment in a foreign bank that already has U.S. branches or agencies, under Federal Reserve regulations the foreign bank is required to notify the Federal Reserve within ten days of the investment and report the shareholding in annual filings with the Federal Reserve.   Return to text

5.   Governor John P. LaWare discussed this position and other issues related to foreign government ownership of foreign banks operating in the United States in testimony before the House Committee on Banking, Finance and Urban Affairs in 1992.  78 Federal Reserve Bulletin 495 (1992). Return to text

6.   Banca Commerciale Italiana, 68 Federal Reserve Bulletin 423 (1982). Return to text

7.   Later in 1982, a subcommittee of the House Committee on Government Operations held hearings on foreign government and foreign investor control of U.S. banks.  Hearing on Foreign Government and Foreign Investor Control of U.S. Banks, before the Commerce, Consumer, and Monetary Affairs Subcommittee of the House Committee on Government Operations, 97 Cong. 2 Sess. (Government Printing Office, 1982).  No legislation, however, was proposed. Return to text

8.   Letter from William W. Wiles, Secretary of the Board, to Patricia S. Skigen (August 19, 1988). Return to text

Finding A Buyer in a Real Estate Transaction

Selling a home is one of the most complex transactions that people are ever involved in. Finding a buyer is often the easy part! When you find someone who wants your home and who has the money to buy it, it is still a long way to the closing table.

You must first negotiate a purchase contract that covers the price and all the terms of the agreement. How much of a deposit will the buyer put down? When and how will the transfer of title occur? Under what conditions can either the buyer or seller back out of the contract? A professional home inspection will inform all parties about the condition of the property.

Having a good agent to handle the details after a home inspection can make the difference between a successful transaction and a failure. The buyer must obtain financing, and the lender's appraiser will have to agree with the sale price. When clear title has been established, you can sign all the necessary papers to finalize the sale.

Selling and What Really Works in Real Estate

If you are trying to sell your home quickly, some real estate agents may recommend that you offer a bonus to the agent who brings in the buyer. They feel that a monetary incentive will cause an agent to push your house over the one down the street. Do such bonuses work?

You cannot expect a bonus to sell an overpriced house or overcome housekeeping shortcomings that detract from your home's overall appeal. If your house looks great and is priced right, offering a bonus to the real estate agent could help it sell more quickly. Agents earn their reputations by helping people find homes that they love. When deciding which homes to show prospective buyers, their decision will be based on whether the home will meet their needs. If the Multiple Listing Service indicates that a bonus is being offered, it could encourage more agents to preview the house and result in more showings.

April 21, 2008 Quotes of the Day - Henry David Thoreau

A man is rich in proportion to the number of things he can afford to let alone.
Henry David Thoreau

A truly good book teaches me better than to read it. I must soon lay it down, and commence living on its hint. What I began by reading, I must finish by acting.
Henry David Thoreau

Aim above morality. Be not simply good, be good for something.
Henry David Thoreau

All endeavor calls for the ability to tramp the last mile, shape the last plan, endure the last hours toil. The fight to the finish spirit is the one... characteristic we must posses if we are to face the future as finishers.
Henry David Thoreau

An early-morning walk is a blessing for the whole day.
Henry David Thoreau

Any fool can make a rule, and any fool will mind it.
Henry David  Thoreau

As a single footstep will not make a path on the earth, so a single thought will not make a pathway in the mind. To make a deep physical path, we walk again and again. To make a deep mental path, we must think over and over the kind of thoughts we wish to dominate our lives.
Henry David Thoreau

Be true to your work, your word, and your friend.
Henry David Thoreau

Making Intelligent Pricing Decisions in Real Estate

Pricing your home is one of the most important decisions you must make when selling your property. Some sellers want to price their home based on the return they would like on their initial investment, while others will base the price on what they need to buy their new home. Location, condition, and accessibility are three other variables that will affect the price of a property.

It is crucial to price your home correctly from the beginning, because it may not sell if it is overpriced. Don't make the mistake of thinking that you can reduce the price later. By this time you will have already lost many potential buyers. The motivation of the seller is a very important factor affecting the pricing decision. The higher the seller's motivation, the lower the price, and low motivation usually means a higher price.

The state of your local real estate market is one of the strongest determining factors when pricing your home. A professional real estate agent will be able to guide you through the pricing pitfalls with a written market analysis that includes the selling prices for similar homes in your area.

Maximum Real Estate Profit

Everyone wants to get the maximum amount possible when they sell their home, but many homes sit on the market because they are overpriced. One real estate axiom states that "the true monetary value of real estate is what someone is actually willing to pay for it". A professional real estate agent determines the asking price of a property by examining the selling price of comparable homes in the area which have closed.

A seller might occasionally be heard to complain that a sales professional "lowballed" their home for a quick, easy sale. However, real estate agents always work to maximize their seller's profit. They price your home based on a careful calculation of the maximum amount you should be able to get (with a little room to negotiate).

If you are really serious about selling your home, work with your sales professional to make sure that it is priced right.

Selling Your Real Estate For Top Dollar

When you get serious about selling your home, the chances of your selling it quickly for top dollar will improve considerably if you list it with a real estate sales professional. If you doubt this, consider the fact that eight out of ten homes sold today--more in some markets--are listed with a professional real estate agent.

Listing your home places it on the local Multiple Listing Service that is subscribed to by a majority of real estate sales professionals. Through the MLS listing, your home is assured of getting the widest possible exposure to the market place.

Some buyers shop the home market on their own, but most save time and money by using the services of a real estate sales professional. Ask yourself which homes the real estate agent is going to show the prospective buyers--homes listed on the MLS or those that are not?

If you still want to try to sell your own home, be aware that you will face stiff competition when it comes to attracting qualified buyers!

Real Estate Marketing Techniques

When a seller lists a home with a real estate agent, a lot of brainstorming follows. Who are the potential buyers, where do they live and work? How can they be reached effectively with information that will attract them to this particular property?

In addition to advertising each home on the widely used Multiple Listing Service, professional real estate agents employ marketing techniques tailored to the individual home they are selling. An agent will review various buyer lists to find potential purchasers. They will use telephone and direct mail marketing, produce property flyers and advertise on the Internet, in the newspaper, in community publications and in real estate magazines. Contacts will be made to other agents who sell homes in the area to encourage them to show the home to prospective buyers.

Real estate agents combine pro-active marketing with realistic pricing to generate results for their home sellers.

Governor Frederic S. Mishkin

Small business lending

Before the Committee on Small Business and Entrepreneurship, U.S. Senate

April 16, 2008

Chairman Kerry, Ranking Member Snowe, and members of the Committee, I am pleased to appear before you on behalf of the Board of Governors of the Federal Reserve System to discuss the availability of credit to small businesses.

Small businesses are critical to the health of the U.S. economy. They employ more than half of private-sector workers, generated well over half of net new jobs annually over the past decade, and create more than half of nonfarm business gross domestic product. Moreover, larger firms often begin as smaller firms that prosper and grow. If small businesses are to continue to provide major benefits to the economy, their access to credit is clearly a high priority. My testimony today will address the unusual stress imposed on credit markets in recent months and how that stress appears to be affecting small businesses.

Small Business Access to Credit and the Current Financial Market Turmoil
As we all know, financial market conditions began to deteriorate quite rapidly in the middle of last August. In response to these and subsequent events, and in recognition that growth of the U.S. economy was slowing, the Federal Reserve has, since last fall, taken a number of strong actions aimed at both restoring the normal functioning of financial markets and at stimulating the real economy.

Although our actions appear to have helped stabilize the situation, financial markets remain under considerable stress. For example, many lenders have been reluctant to provide credit to counterparties, especially leveraged investors, and have increased the amount of collateral they require to back short-term security financing agreements. Credit availability has also been restricted because some large financial institutions, including some large commercial and investment banks, have reported substantial losses and asset write-downs, which reduced their available capital. The capacity and willingness of some large banks and other financial institutions to extend new credit has also been limited by the reduced availability of external funding from the capital markets for originated assets. The resulting unplanned increases in their balance sheets have strained their capital, thus reducing lending capacity. The good news is that several of these firms have been able to raise new capital, and others are in the process of doing so. However, market stresses are likely to continue to weigh on lending activity in the near future.

With this general background in mind, let me now address how the financial market turmoil of the past several months appears to have affected access to credit by small businesses. As you may recall, in my testimony before the House Committee on Small Business in November, I concluded that while credit conditions had no doubt tightened since mid-August, small businesses generally seemed to have been able to retain access to credit.¹ However, I emphasized that the uncertainty surrounding that conclusion was unusually high, and it was far too early to draw any firm conclusions. To some extent that is still the case, although we clearly have more information to work with now in assessing the effects of financial market turmoil on small business access to credit.

In its initial stages, the current financial market turmoil and associated problems in the housing market were focused on markets for securitized assets and affected primarily large financial organizations. In large part because only a small share of small business loans are securitized and because it is the relatively smaller banks that tend to specialize in providing "relationship finance" to small businesses, credit supply to small businesses held up rather well. Still, even in November it was clear that credit conditions had begun to tighten for small businesses.

The trend toward tighter credit supply conditions for small businesses has continued since last fall. For example, in the Board's most recent Senior Loan Officer Opinion Survey, conducted in January, a net one-third of the domestic banks surveyed--a larger net fraction than in the October survey--reported that they had tightened their lending standards on commercial loans to small firms over the previous three months.² Significant net fractions of banks also indicated that they had tightened price terms on commercial loans to both small and large firms. The net fractions of banks reporting tighter lending standards and pricing terms on commercial loans in the January survey were relatively high by historical standards going back to 1990.

Actual loan pricing data from our quarterly Survey of Terms of Business Lending are broadly consistent with the qualitative data from the Senior Loan Officer Opinion Survey. For example, data from our most recent survey, taken in February, indicate that the average interest rate on commercial loans relative to the bank's cost of funds (the bank's spread) rose modestly from the corresponding survey week of three months earlier. Of particular importance for small businesses, however, are the facts that these spreads jumped significantly both on loans originated by smaller U.S. banks and on smaller commercial loans--that is, those loans below $100,000.

Despite tighter credit standards and loan terms, growth in the dollar amount of commercial loans at U.S. banks was quite well maintained in the first quarter of 2008. Particularly noteworthy from the point of view of small businesses is the fact that after growing almost 20 percent in the fourth quarter of 2007, commercial loans at small banks continued to expand at a rate of almost 12 percent in this year's first quarter.³ Thus, although slowing somewhat, commercial loan growth has held up in recent months even though banks' terms have tightened and economic growth has slowed, the latter driving down the demand for small business and other commercial loans. On balance, this suggests that credit is generally available, albeit at a higher cost.

Another source of information about small business credit supply conditions is the monthly survey of the National Federation of Independent Businesses (NFIB). The results of the most recent NFIB survey, conducted in March, suggest that credit supply conditions for small businesses have held up fairly well over the past several months. For example, over the past few quarters only about 3 percent of survey respondents have reported that financing conditions and interest rates were their main business concern, and for March that number was only 2 percent.⁴ In addition, according to the NFIB survey, the average short-term interest rate paid by borrowers has remained at the low end of its historical range. On a less positive note, in recent months the net percentage of NFIB survey respondents that reported credit was harder to obtain over the previous three months and the net percentage that expected credit conditions to tighten over the next three months have been at the upper end of their ranges observed over the past few years. Still, these percentages have remained well below their highs reached in the early 1990s and are below their levels from last September's survey when they temporarily spiked up.

On the demand side, the NFIB survey's results are quite pessimistic. For example, the survey's index of small business optimism has dropped to its lowest level since the monthly surveys began in 1986, as the net percentage of borrowers that believe it is a good time to expand their business has fallen to the bottom of its range over the past two decades. This contrasts sharply with survey responses last September which indicated that the NFIB's index of small business optimism and the fraction of firms that considered the next three months "a good time to expand" had remained at levels similar to those seen in the first half of 2007. If demand conditions continue to deteriorate, reduced demand for loans could lead to future declines in small business loans even if credit supply conditions remain about the same.

A less comforting picture of small business credit supply conditions is provided by the Duke University/CFO Magazine Global Business Outlook survey, conducted most recently in March. About one-third of the chief financial officers (CFOs) of small businesses who responded said credit was more costly, less available, or both as a result of the credit market turmoil. This proportion is up slightly from last September, when that sentiment was reported by about one-fourth of responding small business CFOs. This survey also asks respondents to rank their top three concerns, with the (changing) options given in the survey. "Credit markets/interest rates" was ranked as the second top concern among small business CFOs in both the March 2008 and the September 2007 surveys.⁵

Perhaps one of the most important concerns about the future prospects for small business access to credit is that many small businesses use real estate assets to secure their loans. For example, data from our 2003 Survey of Small Business Finances (SSBF) indicate that 45 percent of the total dollar amount of small business loans outstanding in 2003 was collateralized by some type of real estate asset.⁶ About 37 percent was collateralized by business real estate assets, and 15 percent was secured with "personal" real estate.⁷ Looking forward, continuing declines in the value of their real estate assets clearly have the potential to substantially affect the ability of those small businesses to borrow. Indeed, anecdotal stories to this effect have already appeared in the press.

Similarly, declines in the value of real estate assets held by banks and other lenders could affect their willingness and ability to supply loans, as real estate losses use up capital that could otherwise be used for making new loans. Indeed, there are reasons to believe that these forces are currently at work not only at large banks, where the initial problems were observed, but across the full size spectrum of banking organizations. As noted previously, more stringent loan terms are already in place. In addition, banks across all size groups, including community banks, have recently experienced a sharp deterioration in credit quality, mostly within loans secured by real estate. Moreover, if banks continue to place on their balance sheets some assets that they had expected instead to place in conduits or otherwise sell to investors, the move could crowd out loans to small businesses and other borrowers.

On a more positive note, the vast majority of U.S. banks remain well capitalized. Going forward, this should help these banks to maintain their lending capacity. In addition, lender constraints on small business loans may be mitigated somewhat by loan guarantees provided by the Small Business Administration (SBA).

The interdependencies between small business and household finance are among the most interesting and least understood aspects of small business access to credit. In addition to personal real estate assets, other household assets such as automobiles may be used as collateral for small business loans, and personal credit cards and savings accounts are sometimes used to help finance a small business. For example, our SSBF documents that, in 2003, almost 47 percent of small businesses used personal credit cards in the conduct of their business. At that time, most of this use appeared to have been for convenience rather than for longer-term borrowing. However, to the extent that small businesses become more reliant on credit cards as a source of funding, perhaps because of a decline in their own financial condition or because of a tightening in other aspects of credit supply, they may end up facing higher interest rates than would otherwise be the case.

Conclusion
In conclusion, the health of the U.S. economy depends importantly on the vitality of the small business sector, and continued access to credit on competitive terms is necessary for that vitality. On balance, since last fall credit supply conditions have almost surely tightened for the vast majority of small businesses. Credit appears to be generally available, but at a higher cost. Only a small fraction of small business owners report that credit is their main business concern. Demand for their products is much more problematic.

Looking forward, continuing declines in the value of small businesses' real estate assets have the potential to substantially affect the ability of those small businesses to borrow. Similarly, declines in the value of real estate may affect the ability and willingness of banks and other lenders to supply loans. Indeed, this is likely already occurring to some extent at some banks across the full spectrum of bank sizes. Lastly, because of interdependencies between small business and household finance, declines in the financial condition of households can also affect both the terms of those households' small businesses loans and their ability to borrow.

For all of these reasons, the Federal Reserve will continue to monitor closely the effects of financial market conditions on small business access to credit. More generally, I assure you that the good health of the small business sector is an important consideration for the Federal Reserve as we strive to fulfill the dual mandate given to us by the Congress to promote both price stability and sustainable economic growth.

Footnotes

1. Frederic S. Mishkin (2007), "Availability of Credit to Small Businesses," statement before the Committee on Small Business, U.S. House of Representatives, November 7. Return to text

2. Board of Governors of the Federal Reserve System (2008), "The January 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices" (January). In October, a net 10 percent of banks reported tightening lending standards to smaller firms. The net percent of banks is defined as the percent tightening less the percent easing standards. Return to text

3. The first quarter's numbers have been adjusted for some statistical anomalies in February. Return to text

4. These levels are far below their peaks of the early 1980s, when more than one-third of respondents reported that financing conditions were their main concern. Return to text

5. The top concern in March was customer demand, whereas the top concern in September was the cost of labor. Return to text

6. Board of Governors of the Federal Reserve System (2003), "2003 Survey of Small Business Finances"; Traci L. Mach and John D. Wolken (2006), "Financial Services Used by Small Businesses: Evidence from the 2003 Survey of Small Business Finances (185 KB PDF)," Federal Reserve Bulletin, vol. 92 (October), pp. A167-A195. Return to text

7. The two components sum to more than 45 percent because some loans are collateralized by both business and personal real estate. Return to text

Vice Chairman Donald L. Kohn

At the Federal Reserve Bank of Richmond's Credit Market Symposium, Charlotte, North Carolina

April 17, 2008

The Changing Business of Banking: Implications for Financial Stability and Lessons from Recent Market Turmoil

The recent market turmoil certainly has underscored how banking and financial intermediation have been changing, and it has taught some important lessons about the implications for financial stability that I don't believe were previously well understood. Commercial banks and other financial market participants need to incorporate those lessons into their risk-management practices. Bank supervisors need to encourage and monitor banks' efforts to strengthen their practices and we need to consider how regulatory and supervisory policies should be modified to reinforce incentives for sound practices. Finally, changes in the ways savings are channeled to borrowers have also affected the role of the nonbank sector. Central banks and other policymakers need to think carefully about the implications of these changes for financial stability and the appropriate prudential regulation of nonbank financial institutions.¹

The Changing Business of Banking
Even before the recent market turmoil, it was abundantly clear that the business of banking has changed quite significantly over the past several decades. The primary impetus for change has been intensified competitive pressures from the securities markets. Changes in technology (for example, the development and expansion of credit-scoring techniques) have allowed a larger share of credit extensions to households and businesses to be packaged in securities and sold to entities that often can fund the securities more cheaply than banks can fund loans. The effects probably have been greatest for the U.S. household sector. Securitization of residential mortgages began in the 1970s; the share of outstanding mortgages that have been securitized grew fairly steadily throughout the 1980s and 1990s and has fluctuated between 50 and 60 percent since then. Nonmortgage consumer credit (credit card and installment debt) began to be securitized in the late 1980s, and in recent years more than 20 percent of the outstanding stock has been securitized. Until the summer of 2007, there was very strong demand for securitized credit from mutual funds, pension funds, and other institutional investors. Throughout that period, household wealth was rising rapidly, and, directly or indirectly, households were allocating an increasing share of their wealth to vehicles that were managed or advised by professional asset managers. At the same time, advances in the technology of modeling, pricing, and trading of risk over the past several decades gave added impetus to the migration of credit to securities markets.

Competition from the securities market has significantly affected all segments of banking, but the most dramatic changes have occurred at the very largest banks. One could say that their strategic response was, "If you can't beat them, join them." Freed from the constraints of the Glass-Steagall Act by incremental regulatory changes that were expanded and codified in the Gramm-Leach-Bliley Act of 1999, the very largest banking organizations have significantly increased their capital markets businesses, including arranging and underwriting securitizations, securities custody, prime brokerage, and both over-the-counter and exchange-traded derivatives. They have also made significant inroads into both traditional asset management and the management of hedge funds. Indeed, the largest commercial banks are now major competitors in many of the business lines that were historically viewed as the province of investment banks. Together, the very large commercial and investment banks have become indispensable to the efficiency and stability of the securities markets. For example, the $2 trillion hedge fund sector is critically dependent on a relatively small number of commercial and investment banks that serve as secured creditors and derivatives counterparties. And, as the financial market turmoil has revealed, banks provide liquidity support to various short-term financial markets, including the commercial paper market and markets for various types of tax-exempt debt.

Competition from securities markets has also affected smaller banks significantly, though less dramatically than larger banks. For example, the portfolio share of commercial real estate loans, which are not amenable to standardization and therefore are difficult to securitize, has increased markedly. Setting aside the 100 largest banks, the share of commercial real estate loans in bank loan portfolios nearly doubled over the past 10 years and is approaching 50 percent. The portfolio share at these banks of residential mortgage and other consumer loans, which are more readily securitized, fell by 20 percentage points over the same period.

The Implications for Financial Stability from the Recent Market Turmoil
The changing business of the largest commercial banks means that threats to financial stability do not necessarily come from traditional sources such as a deposit run or a deterioration in a bank's portfolio of business loans. The largest banks' capital markets businesses have given rise to new threats to financial stability. These threats stem from banks' securitization activity, from the complexity of banks' capital markets activity, and from the services that banks provide to the asset-management industry, including hedge funds. And risks that are more traditional to banking, such as liquidity risk and concentration risk, have appeared in new forms.

The securitization activity of the largest banks is often described as following an originate-to-distribute model. Chairman Bernanke described this model in some detail in a speech he gave last week in Richmond.² In an originate-to-distribute model of banking, assets are originated to be packaged into securities, which are distributed broadly.

However, in the recent market turmoil, problems arose at both ends of the originate-to-distribute chain as it was being applied to subprime mortgages. The quality of subprime origination declined because of a serious erosion in underwriting standards at banks and especially at nonbanks. Underwriting standards for subprime mortgages fell as loans were increasingly made on the basis of expected increases in collateral value, without a careful evaluation of the borrower's ability to repay. Several years of rapidly rising house prices had reduced the delinquency rates on mortgages with historically high loan-to-value ratios, making these mortgages look less risky than they, in fact, turned out to be. As loan amounts rose relative to the value of properties, the performance of the subprime mortgage sector as a whole became sensitive to even small declines in house prices, with the distressing results that we have seen since house price growth decelerated beginning in 2006. A similar decline in underwriting standards occurred in other market segments, such as the market for leveraged loans, where banks increasingly originated loans with less-stringent covenants through the first half of last year. More generally, insufficient appreciation that economic conditions might not always be benign and that trading conditions in markets might not always be highly liquid led to an underpricing of both credit and liquidity risks.

At the other end of the originate-to-distribute chain, a good part of the risk associated with the securitization of subprime mortgages was not distributed into the market but was retained by banks. The most glaring example is their exposures to super senior tranches of collateralized debt obligations (CDOs) that had invested in subprime mortgage-backed securities. Super senior CDO tranches--the last to bear the costs of defaults on the underlying mortgages--were considered to be extremely safe investments, and little of the risk of these instruments was truly distributed into the market.

Three things hindered the distribution of super senior CDO risk. First, underwriters sold some of the risk to off-balance-sheet vehicles, but they also provided explicit or implicit liquidity backstops to the vehicles. Much of this risk came back onto banks' balance sheets when liquidity pressures emerged in the second half of last year. Second, underwriters chose to retain some of the super senior exposure, in some cases reportedly because they met some resistance when they attempted to sell them at very slim spreads. The underwriters evidently misjudged the risk of those positions, in some cases because they relied too heavily on external triple-A ratings. Third, underwriters hedged some of the risk with monoline financial guarantors. But some of the guarantors took on so much subprime-related risk that their financial condition had become highly correlated with the performance of the subprime mortgage sector, which has called into question the effectiveness of those hedges.

As I mentioned earlier, the growth of securitization is in large part a response to the growing demands of institutional investors for fixed-income securities. These investors clearly had a financial incentive to do better due diligence on the subprime risks they were taking on, but they largely failed to do so. We can only speculate as to why this was the case. I see three possibilities: First, they underestimated the potential for a nationwide decline in house prices; second, they relied on credit-rating agency analyses that have proven to be inadequate; or third, they simply misunderstood the risk of these often very complex securities.

The complexity of CDOs is one example of a widespread increase in the complexity of the capital market activities in which the largest banks now engage. Some banks' failure to adequately manage this complexity has weakened financial stability in the current market turmoil. CDOs and other structured credit products can be very complicated. Among the CDOs that invested in subprime mortgage-backed securities, it was common for a single CDO to own hundreds of different mortgage-backed securities, each with its own pool of underlying mortgage loans. Clearly, the valuation of such products and the measurement and hedging of the risks they entail are very complicated. Securities pools reduce idiosyncratic risk--the potential for problems particular to individual borrowers to have a material effect on overall values--but they are quite subject to systematic risk from broad-based macroeconomic developments that affect all loans at the same time. I believe it is fair to say that the creation of new, innovative financial products outstripped banks' risk-management capabilities. As I noted earlier, some banks that chose to hold super senior CDO securities did so because they trusted in an external triple-A credit rating. Because some banks did not fully understand all aspects of these exposures, once the risks crystallized last year in a weak house price environment, compounded by widespread liquidity pressures in many markets, banks had to scramble to measure and hedge these risks.

Another aspect of the changing business of banking with possible implications for financial stability is the growth of services that banks provide, including running their own asset-management businesses and providing prime brokerage services to hedge funds. Banks with asset-management businesses must manage the reputation risk that such businesses entail. Because institutional investors are naturally sensitive to the reputation of their asset managers, losses elsewhere in the bank can be compounded if they leave the bank's asset-management business exposed to a flight of business and a sharp reduction in fee income. An increase in the business that banks do with highly leveraged investors, like some hedge funds, leads to an increase in the attention that banks must pay to counterparty risk management.

Liquidity risk is a familiar risk to banks, but it has appeared in somewhat new forms recently. While the originate-to-distribute model aims to move exposures off of banks' balance sheets, the risk remains that a sudden closing of securitization markets can force a bank to hold and fund exposures that it had originated with the intent to distribute. And in many cases when banks did distribute exposures, they did so to various off-balance-sheet financing vehicles in which they retained contractual and reputational liquidity exposures. These vehicles, like banks themselves, were funding longer-term assets with short-term liabilities, and, like banks, they were subject to a run when their lenders became concerned about the quality of the assets. Some banks wound up using their own liquidity to support financing vehicles that were no longer able to fund themselves on anything like the same terms and conditions as before the market turmoil began. And as banks made good on the implicit or explicit liquidity insurance they sold, they found themselves with larger balance sheets and less-robust capital cushions than they anticipated. As the banks' capital and liquidity cushions unexpectedly eroded, they became quite cautious about extending credit, a dramatic change from the more complacent attitudes of previous years.

Concentration risk is another familiar risk that is appearing in a new form. Banks have always had to worry about lending too much to one borrower, one industry, or one geographic region. But as smaller banks hold more of their balance sheet in types of loans that are difficult to securitize, concentration risks can develop. Concentrations of commercial real estate exposures are currently quite high at some smaller banks. This has the potential to make the banking sector much more sensitive to a downturn in the commercial real estate market.

The Private Sector Needs to Respond
To protect their capital and liquidity, banks and other financial market participants are addressing the weaknesses revealed by market developments by becoming much more careful about the risks they are taking. This is a necessary process, but it has been a difficult one as well; it is reducing the values of some assets and tightening credit cost and availability across a wide range of instruments and counterparties, despite considerable easing in the stance of monetary policy. It is this tightening that is accentuating the downside risks for the economy as a whole. And in some sectors, as lenders seek protection against perceived downside risks, it is probably going further than is necessary to foster financial stability in the long run. But we will end up with a safer, more robust financial system.

For banks, a safer and more robust financial system will be characterized by improved risk management that incorporates the lessons from the recent turmoil. Successful risk management looks comprehensively across business lines and is fully integrated into the decisionmaking of senior management. It identifies stresses and scenarios that might seem remote, but that could threaten safety and soundness. Banks' own self-interest clearly provides a strong incentive to improve risk management, but better risk management at the largest banks would benefit the broader financial system, too.

A more resilient financial system will also require banks to strengthen all aspects of the originate-to-distribute model. They need to pay more attention to origination, including when they are distributing credits they have not originated. And they need to ensure that when they distribute risks into the market with securitization, the risks really are distributed and will not come back onto their balance sheet later. If the credits end up in off-balance-sheet entities, banks need to pay more attention to the capital and liquidity impact of any residual claim these entities may have on the banks, even where that claim may arise through a desire to protect the bank's reputation rather than through any contractual obligation.

The structured credit products that are part of a safer banking system are likely to be simpler and more transparent. Recent experience has shown that more readily understood products would be in banks' own self-interest. Banks and investors must devote more effort to due diligence when investing in structured products, and they must avoid relying so heavily on credit rating agencies to do all their homework for them.

Banks must continue to focus on improving their management of counterparty risks. During the financial market disruptions surrounding the hedge fund Long-Term Capital Management almost 10 years ago, counterparty risk was a central concern. Subsequently, a private-sector group called the Counterparty Risk Management Policy Group developed a set of best practices for counterparty risk that greatly helped to set the tone for the needed improvements. These efforts do not appear to have been wasted, as attested to by the lack of serious losses from defaults of hedge fund counterparties in the recent turmoil. However, banks do not appear to have followed those best practices for their counterparty relationships with monoline financial guarantors, where counterparty risk has crystallized into large losses.

Banks must come to grips with the implications that their capital markets businesses have for liquidity risk management. While securitization can transform illiquid assets into more-liquid securities, risk managers must be more aware of the ways that securitization can become a drain on a bank's liquidity position in times of stress.

Smaller banks, too, need to improve aspects of their risk management. They should take steps to manage any portfolio concentrations that may arise because competition from securitization is less intense in certain market segments. When they do increase the share of their portfolio in a given market segment above historical levels, they must ensure that their risk-management processes and controls are commensurate with the level and complexity of their exposures.

All banks--large and small--need to consider whether they need greater capital cushions. The largest banks should consider whether their changing business model means that they need to hold more capital against some of the newer risks I discussed earlier. It is especially concerning that so many of these newer risks have arisen at the same time. Smaller banks must make sure their capital is sufficient to protect against the risk associated with the greater concentrations that have seemed to accompany the increased competition from securities markets.

Banks might find the current circumstances to be especially favorable for raising new capital. Not only would more capital provide a cushion against the sorts of unexpected declines in creditworthiness and asset values that have marked recent months, it would also position banks well for expansion. The safer, more resilient financial system that will emerge from this episode is likely to be characterized by a greater reliance on bank financing, as borrowers and lenders take on board the weaknesses that have become evident in securities markets. It also is likely to offer more generous compensation for risk-bearing. For banks with plenty of capital, that adjustment process is likely to present a chance to pick up business that, appropriately managed, will prove quite profitable over time.

I acknowledge that this is a formidable "to do" list for banks. But it has been a formidable episode of financial turbulence that has revealed major weaknesses in our financial system, including the business practices of many banks. And this episode has also left the regulators with many issues to consider.

The Federal Reserve and Other Regulators Need to Respond
At the Federal Reserve and at other bank regulatory agencies, our job is to reinforce the incentives and actions that are building a more resilient financial system. We need to make sure that regulatory minimum capital requirements and liquidity management plans protect reasonably well against shocks becoming systemic. Our supervisory guidance needs to be in place to prevent backsliding when, over the coming years, the memories and lessons of the current market turmoil fade, as they certainly will.

To these ends, we are reexamining a host of things ranging from Basel II to liquidity to transparency. Working with our domestic and international colleagues, we are looking to raise the Basel II capital requirements on specific exposures that have been troublesome, such as super senior CDOs of asset-backed securities and off-balance-sheet commitments. We are looking to the Basel Committee on Banking Supervision to update its guidance on liquidity management in light of the recent experience. And we and our supervisory colleagues are looking to require better disclosures of off-balance-sheet commitments and of valuations of complex structured products.

Threats to Financial Stability from Outside the Banking System
In the past, commercial banks and securities markets could be considered as separate channels for credit intermediation. One important implication of this was that if one channel for credit provision became impaired, the other would usually be functioning and able to insulate, to a degree, overall credit provision and the economy from financial sector shocks. For example, when the depository credit channel became impaired in the late 1980s and early 1990s, many borrowers were able to turn to liquid securities markets to meet a substantial portion of their needs for credit.

That isn't working in the current period of turmoil, and for the reasons inherent in our discussion so far. First, securities markets have become so large that commercial banks simply lack sufficient capital and balance sheet capacity to readily fill the gap when markets are impaired. We saw this initially in mortgage markets when the securitization of nonconforming mortgages seized up; banks stepped up to make more jumbo prime mortgages and hold them on their books, but the cost of such credit rose substantially, and the amount of lending was reduced.

Second, banks themselves are more dependent on well-functioning securities markets, and as that dependence and the important role of banks as ultimate providers of funding to those markets became clearer, pressures on banks mounted. So, in August, the turmoil crossed into the banking system when banks were challenged to backstop asset-backed commercial paper conduits and structured investment vehicles; under these circumstances, they were no longer comfortable fulfilling their traditional lending roles, and they tightened lending terms substantially, becoming part of the problem of credit availability, rather than a solution to it. In our more security-oriented intermediation systems, both commercial banks and security markets seem to be critical to the stability of the financial system and the economy.

Third, large commercial banks and investment banks have increasingly similar risk profiles, so that all are subject to the same risk-management challenges under the same circumstances. As the activities and risk profiles of large banks and securities firms have become increasingly similar, and as financial intermediation has run more through securities markets, we've certainly learned in the past month or so that it is not only commercial banks that can threaten financial stability.

So we must worry about excessive leverage and susceptibility to runs not only at banks but also at securities firms. To be sure, investment banks are still different in many ways from commercial banks. Among other things, their assets are mostly marketable and their borrowing mostly secured. Ordinarily, this should protect them from liquidity concerns. But we learned that short-term securities markets can suddenly seize up because of a loss of investor confidence, such as in the unusual circumstances building over the past six months or so. And investment banks had no safety net to discourage runs or to fall back on if runs occurred. Securities firms have been traditionally managed to a standard of surviving for one year without access to unsecured funding. The recent market turmoil has taught us that this is not adequate, because short-term secured funding, which these firms heavily rely upon, also can become impaired.

With many securities markets not functioning well, with the funding of investment banks threatened, and with commercial banks unable and unwilling to fill the gap, the Federal Reserve exercised emergency powers to extend the liquidity safety net of the discount window to the primary dealers.³ Our goal was to forestall substantial damage to the financial markets and the economy. Given the changes to financial markets and banking that we've been discussing this morning, a pressing public policy issue is what kind of liquidity backstop the central bank ought to supply to these institutions. And, assuming that some backstop is considered necessary because under some circumstances a run on an investment bank can threaten financial and economic stability, an associated issue is what sorts of regulations are required to make the financial system more resilient and to avoid excessive reliance on any such facility and the erosion of private-sector discipline.

I don't have ready answers to these difficult questions. It is evident that the balance of market discipline and regulation is in the process of being adjusted to the reality of how our financial system has evolved. In my remarks, I've stressed the need for both private and public actions to build a more resilient financial system. But we need to make adjustments in such a way as to preserve the benefits of highly innovative financial markets where many advances have enabled risks to be better diversified and credit more readily available to more people.

Whatever type of backstop is put in place, in my view greater regulatory attention will need to be devoted to the liquidity risk-management policies and practices of major investment banks. In particular, these firms will need to have robust contingency plans for situations in which their access to short-term secured funding also becomes impaired. Commercial banks should meet the same requirement. Implementation of such plans is likely to entail substitution of longer-term secured or unsecured financing for overnight secured financing. Because those longer-term funding sources will tend to be more costly, both investment banks and commercial banks are likely to conclude that it is more profitable to operate with less leverage than heretofore. No doubt their internalization of the costs of potential liquidity shocks will be costly to their shareholders, and a portion of the costs likely will be passed on to other borrowers and lenders. But a financial system with less leverage at its core will be a more stable and resilient system, and recent experience has driven home the very real costs of financial instability.

Footnotes

1. Michael Gibson and Patrick Parkinson, of the Board's staff, contributed to these remarks. The views expressed in these remarks are my own and do not necessarily reflect those of my colleagues on the Board of Governors. Return to text

2. Ben S. Bernanke (2008), "Addressing Weaknesses in the Global Financial Markets: The Report of the President's Working Group on Financial Markets," speech delivered at the World Affairs Council of Greater Richmond's Virginia Global Ambassador Award Luncheon, Richmond, Va., April 10. Return to text

3. Primary dealers are banks and securities broker-dealers that trade in U.S. government securities with the Federal Reserve Bank of New York. On behalf of the Federal Reserve System, the New York Fed's Open Market Desk engages in the trades to implement monetary policy. Return to text

• Paperwork. Gathering all the information needed to evaluate a short-sale offer can take time, says Patrick Carey, an executive vice president with Wells Fargo. The loan servicer must first determine whether the homeowner really can't continue meeting the loan payments, then get an appraisal or broker's opinion of the home's value.

• Many steps, approvals. Mortgage servicers also try to ensure that the proposed sale is an "arm's length" transaction between two parties rather than something like a sale to a relative on sweet terms. They must also determine whether the buyer has sufficient funds or the ability to get a loan. If all those hurdles are cleared, the servicer may still need to get approval from the investor that owns the loan and provide an analysis showing that the investor will be better off with a short sale than with another solution.

• Complications often arise. There are additional complications if the borrower has a mortgage and a home-equity loan. In that case, both parties must approve the deal – which is a challenge when the sales price may not even be enough to cover the mortgage balance.

• Minimize delays. Carey suggests that home owners contemplating a short sale immediately call the loan servicer to get the approval process started, rather than wait for an offer.

• Washington, D.C. Annual delays per commuter: 60 hours; commutes longer than 45 minutes, 28.3 percent.
• Atlanta. 60 hours; 24 percent.
• Los Angeles. 72 hours; 19 percent.
• San Francisco. 60 hours; 20 percent.
• Houston. 56 hours; 17.3 percent.
• New York. 46 hours; 43 percent.
• Riverside-San Bernardino. Calif. 49 hours; 23 percent.
• Chicago. 46 hours; 25 percent.
• Dallas. 58 hours; 16.5 percent.
• Boston. 46 hours; 20 percent

Your Real Estate Selling Strategy

Have your housing needs expanded along with your income? Are you are thinking about selling your property and looking for a new home? The transition can be accomplished smoothly by using a systematic approach.

As part of your selling strategy, it is advantageous to have your present house under contract before you begin a serious search for a new home. This will make you attractive to sellers in two ways. You won't have to include a contingency in your offer to cover the sale of your present home. You will strengthen your negotiating position by improving your financial circumstance with an accepted offer. In a situation where there are multiple offers on the new home, the chances of your offer being accepted are better if it isn't dependent on selling another house before you can make a move.

Qualified Home Movers

Whether you are moving across town or across the country, it is a good idea to shop around for a household mover. Local moving companies have always been very competitive. When interstate movers were more regulated by the Interstate Commerce Commission, they charged basically the same rates. Since that industry has been de-regulated, the rates are varied and even negotiable.

If you are in the market for a mover, get recommendations from friends or neighbors. Call several companies for estimates and ask how their rates are calculated. Find out what kind of insurance against damage or breakage is included in their charges and what additional coverage will cost. The charges are usually broken down into two areas--packing, and loading and unloading. You can sometimes save a considerable amount of money by doing your own packing, but doing so may limit the mover's liability.

A Tough Real Estate Sale

Here is a situation that many buyers have experienced. After searching for weeks, you found the perfect home and you made a very low offer. The sellers responded with a counter-offer which was several thousand dollars lower than their asking price. You came back with a slightly higher bid, and they came down some more. After many days of back and forth, you finally reached a meeting of the minds, and you are very pleased with the results.

If you have driven a hard bargain in purchasing a house, be sensitive to the seller's feelings as the transaction proceeds. They may be suffering from the impact of a rough negotiation. Try to minimize any additional requests you might make of the sellers. As you move toward your closing date, keep in mind that the sellers may not share your elation. If you are considerate and avoid making excessive demands, you can help everyone walk away from the transaction feeling satisfied with the outcome.

8 investing keys from Warren Buffett's latest letter

Strategy Lab is MSN Money's stock-picking challenge.

• A traditional IRA lets you deduct annual contributions (currently set at $3,000, or $3,500 if you’re age 50 or older) from your income. However, once you begin withdrawing money, those funds will be taxed as regular income.

• A Roth IRA gives you no deduction on your current contributions (again $3,000), but does allow you to withdraw funds tax-free. If you expect to buy a real estate investment in an IRA and hold it for a long period, this is probably your best option, particularly if the property increases in value over that period.

• A SEP-IRA is designed for self-employed individuals and small companies. You can contribute up to 25 percent of your compensation, or $40,000, whichever is less. However, keep in mind that if you have employees, you must make contributions for them as well. This option is a great alternative for real estate practitioners who can make the higher contributions because they can build up funds more rapidly to purchase properties. Withdrawals from a SEP-IRA are treated like those of a traditional IRA for tax purposes.

House Hunting Tips

If you are house-hunting, you may spend hours looking at homes only to have them all blend into one giant blur at the end of the day. Which house had that beautifully designed great room? Was it the same one with the small master bedroom? You can remember what is important about each of the many properties that you saw by using the little tricks developed by real estate agents to help them identify the thousands of properties they see.

Carry a notebook with you when you are house-hunting, and give each house its own page. At the top of the page, note the address and price. Write down the exterior construction, style and color, as well as the color of the living room carpet and walls and any other major feature that will jog your memory later. You can nickname the houses--"the cow mailbox house" or "organic garden house"--anything to help you retain a mental picture of the property. This will enable you to recap the day and give your real estate agent important feedback that can speed up your search for the perfect home!

First Time Home Buyers

People who are selling their homes should know something about the market group from which their buyers are likely to appear. Many homes are perfect for a first-time buyer. First-time buyers are making a major purchase they have never attempted before, and may be unusually subject to the inevitable stress and anxiety that goes with buying a home.

First-time home buyers are usually younger (between 25 and 34 years of age) and have distinct buying patterns. First-timers are often looking for homes that are smaller, and perhaps older, than repeat buyers. The median home size for first-time buyers is about 1450 square feet. Approximately four in ten first-timers will buy homes built before 1960, compared to two in ten repeat buyers.

First-time buyers are in the process of developing a clearly defined sense of what they want in a house. They may not have enough money to buy their ultimate dream home at first, but seventy-four percent say they like their new home better than their previous residence.

First Time Loans

Most first-time buyers can qualify for a mortgage loan, but they may need help from parents to make the down payment or closing costs on their home. There are loan programs that minimize the down payment and closing costs for first-time buyers. These programs usually require that 3 to 5 percent of the purchase price come from the buyers' funds, not from a loan or gift. Most lenders ask for the last three months' bank records. The borrower will be asked to reveal the origin of any large deposits. If the money comes from the homebuyer's parents, the lender may not consider those funds when qualifying the buyers.

Parents who are planning to help their children finance a home should transfer any funds several months before the house-hunting process begins. If it is a loan rather than a gift, a formal re-payment agreement should be drawn up between parents and children to eliminate potential misunderstandings or future complications with either estate.

Affording A Home (First Time Home Buyers)

Are you getting ready to buy your first home? It is important to know how much you can afford before you begin looking at properties. Talking with a lender and getting pre-approved for a loan puts you in a stronger negotiating position with sellers.

As a rule, your monthly housing costs should not exceed 28% of your monthly pre-tax income. These costs include the mortgage payment, real estate taxes, and insurance. If you have long-term debts, such as student loans or car payments, your monthly payments, including your housing costs, should be less than 36% of your pre-tax monthly income. Some loans, such as VA and FHA loans, are more flexible with these basic guidelines.

Depending on which type of mortgage you select, you can consider houses in various price ranges. An adjustable-rate mortgage will usually enable you to qualify for a higher loan amount. Your real estate agent can help you make the basic calculations. Remember that buying at the top end of your price range gives you more time to outgrow your home, and can save you money over the long term.

Reducing Indoor Air Pollution

Air pollution is a fact of life in the 21st century. Reducing our use of pollutants will improve the environment and the health of those who live on our planet. But what about indoor air pollutants? The air quality inside your home affects you too, especially since most people spend more time indoors than outdoors.

Indoor air pollutants include elemental particles and gases produced by wood smoke and propane gas ranges. Some building materials, home furnishings and cleaning products emit toxic organic chemicals like formaldehyde that can contribute to poor indoor air quality. Outdoor pollutants such as radon gas from the soil under your home, carbon monoxide and nitrogen dioxide from the vehicles that drive by or pesticides from your neighbor's orchard can also seep inside your house.

How can you reduce the risk of negative health effects from indoor air pollution? First, check the contents of the household products you use, and always open the windows if there are warnings about fumes. You can buy a relatively inexpensive detector for indoor toxic emissions at your local hardware store. If air exchange is poor inside your home, consider installing a mechanical ventilation system that will maintain a healthy flow of air and filter out pollutants.

Detecting Elevated Radon Levels

Radon gas is a colorless, odorless, radioactive gas that can pose a serious health risk if it becomes trapped under your house. Radon typically enters the home via underground crawl spaces, sump pumps, gaps in the basement and even the water supply. It can pollute your indoor air with its toxic vapors, and is held responsible for more than 20,000 lung-disease-related deaths every year. Radon is assumed to be present in millions of American homes.

How do you detect the presence of radon gas, and how can you reduce its presence and influence if it is found in your home? First, have your home tested by a professional. Many contractors are licensed or certified by state and/or local agencies. They will conduct diagnostic testing to determine if radon gas is at acceptable levels. If levels are dangerous, the contractor can install a radon reduction system. Ask the contractor for references documenting the results of past work in other homes. Make sure the company checks the house after the system is installed, to verify that it is reducing the radon levels.

• Too noisy. Barking dogs and rattling air conditioners are among the excessive noise complaints that most rankle neighbors. Solution: Try talking with neighbor about bothersome noise. There may be an easy solution - extra carpeting, piano practice limited to certain hours, outdoor parties moved inside after 11 p.m. If not, the noise-sensitive might be happiest living somewhere with large yards.

• My view is ruined! We're not just talking about new construction that blocks your view of the water. The case of the Commonwealth of Massachusetts vs. Michael Palermo is expected to be heard in the Lowell Superior Court next month. The case deals with Palermo and his neighbor, a single mother of two young children. Local police charged Palermo with a string of misdemeanor and felonies because he stood naked in front of a window. Tyngsborough Deputy Police Chief Richard Burrows says, "The window he was using for exposing faced the street. Not just the victim could see him, but potentially anybody on or near the street could see this going on." Solution: Before buying, check zoning of nearby land and look into neighborhood construction plans. If all else fails, keep the drapes drawn.

• That house is ugly. One side of the house is painted bright yellow; the other is a dark green. MIT professor Richard de Neufville, who lives on the yellow side, says the answer is peaceful coexistence. Before a difference in taste escalated into a much larger issue, de Neufville and his neighbor determined color coordination wasn't worth a fight. “This is life in the big city. I'm not against, in principle, having the same color, but I don't think I have to make a special effort," says de Neufville. Solution: Talk it out with neighbors rather than let resentment build, but pick your fights carefully. Is it really worth an argument?

• Do prep work before the event: Do research of nearby home sales, other properties on the market in the general vicinity, and local schools as well as ensure the property is in top condition.
• Advertise open houses online and through traditional outlets such as the newspaper and using yard signs.
• Don't hide in the kitchen. Present yourself professionally and be visible at the open house. Open the door as guests arrive and offer to answer any questions. But on the other hand, don't be overhearing. Avoid bombarding visitors with questions about their buying status, as even individuals touring the home just to see what it looks like might hire the agent later on if a good first impression is made.
• Think an open house visitor is just "snooping"? Treat them just as if they're a serious buyer while they're at your event. They may be snooping around for a real estate agent, after all. Or if they live nearby, they may remember you in a positive light when they're looking to sell.
• Give visitors something that they'll truly value as they search for homes; Lones prepares a book that includes the open house listing and other homes for sale in the area that are priced $50,000 above and $50,000 under the featured property. The book should include directions to each listing, as well as pictures and a space for prospective buyers to jot down notes for comparisons.

• 30-year fixed-rate mortgages increased to 5.78 percent from 5.75 percent
• 15-year fixed-rate mortgages increased to 5.39 percent from 5.27 percent
• 1-year ARMs increased to 7.06 percent from 7 percent

Chairman Ben S. Bernanke

At the Jump$tart Coalition for Personal Financial Literacy and Federal Reserve Board Joint News Conference, Federal Reserve Board, Washington, D.C.

April 9, 2008

The Importance of Financial Education and the National Jump Start Coalition Survey

Good morning. It is my pleasure to welcome you to today's briefing on the results of the Jump$tart Coalition's biennial financial literacy survey of America's high school seniors.

The financial preparedness of our nation's youth is essential to their well-being and of vital importance to our economic future. In light of the problems that have arisen in the subprime mortgage market, we are reminded of how critically important it is for individuals to become financially literate at an early age so that they are better prepared to make decisions and navigate an increasingly complex financial marketplace. Choosing a credit card, saving for retirement or for a child's education, or buying a home now requires more financial savvy than ever before. Financial literacy and consumer education--coupled with robust consumer protection--makes the financial marketplace effective and efficient, and better equips consumers to make tough yet smart financial decisions. Today, only eight states across the U.S. require personal finance before middle or high school graduation. I believe more states should consider making personal finance a requirement for all students who seek a high school diploma. I am personally convinced that improving education is vital to the future of our economy and all its citizens, and I strongly believe that promoting financial literacy, in particular, must be a high priority. I know that those of you here today join me in this conviction.

The Jump$tart Coalition is a leader among organizations seeking to improve the personal financial literacy of students from kindergarten to the university level. In particular, through its biennial survey of high school seniors--the results of which you will hear about shortly--Jump$tart has brought increased attention to the need for greater financial literacy among the youth of our nation. During the Jump$tart survey's 12-year history, the data gathered have served as the basis for useful measures of what young adults do and don't understand about finances. Undoubtedly, we will soon learn that there is plenty of work to be done and that our students have much to learn.

The Federal Reserve is strongly committed to Jump$tart's mission to better educate America's youth about personal finance.  On the regional level, many Federal Reserve Banks work closely with the state coalitions to help achieve this worthy mission. In fact, there is at least one economic education specialist at each of the Reserve Banks and their branches. Many of these specialists offer training seminars to help educators teach vital economic and personal finance topics in their classrooms. The Federal Reserve also continues to support a variety of programs and initiatives to increase financial literacy. These include:

• Money Smart Week, an annual week-long program coordinated by the Federal Reserve Bank of Chicago, which educates consumers about money management and promotes financial education awareness in 20 cities across the 7th District;
• Building Wealth, a resource developed by the Federal Reserve Bank of Dallas to help consumers develop a personal plan for building wealth;
• "Life Smarts," a national quiz-based competition for high school students sponsored by the National Consumer League and promoted by many Reserve Banks;
• Educational web sites, such as the Federal Reserve Bank of San Francisco's "FedVille," where students actively learn more about financial concepts such as spending, saving, and earning interest; and
• FederalReserveEducation.Org, our system-wide education web portal offering easy access to a host of beneficial resources geared toward students, parents, and teachers. 

In addition to these and many other Federal Reserve resources, we will continue to work to expand the resources and programs devoted to the important public policy challenge of improving financial literacy.

I want to take this opportunity to thank the Jump$tart Coalition and their partners for their continued support and commitment to furthering the financial education of our youth.   Now, it is with great pleasure that I introduce Laura Levine, executive director of Jump$tart and appointed member of President Bush's recently formed Council on Financial Literacy, who will give a report on the status of financial education of youth in this country.

Governor Randall S. Kroszner

Federal Housing Administration Housing Stabilization and Homeownership Act

Before the Committee on Financial Services, U.S. House of Representatives

April 9, 2008

Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am pleased to be here today to discuss efforts to address the current problems in the mortgage and housing markets. In my testimony this morning, I will briefly review the current situation in the housing market and ongoing efforts to help prevent avoidable foreclosures. Then I will expand on what additional steps might be taken by homeowners, lenders, servicers, investors, and the Congress to address this important issue. I will also address the need to take the housing situation seriously and some aspects of the discussion draft of the Federal Housing Administration (FHA) Housing Stabilization and Homeownership Retention Act of 2008.

The Current Situation
The mortgage market has long been a source of strength in the U.S. economy, but it is facing very significant challenges today, especially in the subprime segment that serves consumers who have shorter or weaker credit records. In recent years, slowing home prices and a loosening of underwriting standards have contributed to sharp increases in delinquencies and foreclosures. As of January 2008, the most recent month for which data are available, about 24 percent of subprime adjustable-rate mortgages (ARMs) were 90 days or more delinquent, twice the fraction that were delinquent by this definition one year ago. For mortgages overall, more than 1.5 million foreclosures were started during 2007, up 53 percent from the previous year. All told, the consensus expectation is that the number of foreclosures in 2008 will likely exceed the number in 2007.

Both delinquency and foreclosure are traumatic experiences for the families and communities affected. Recent declines in house prices have eroded the equity that homeowners have in their homes, which has made it difficult or impossible for many of them to refinance their mortgage on more favorable terms compared to their current mortgage, even if interest rates have declined since they took out their loan. Tighter lending standards have also limited opportunities for these families to refinance. When struggling homeowners cannot put themselves on a sustainable financial footing, neighborhoods also suffer--properties are not maintained and foreclosures, particularly when they are clustered together, put further downward pressure on house prices. This is bad news for investors, too, because as property values decline, the substantial costs associated with foreclosure rise even further. Finally, falling home prices can have local and national consequences because of the erosion of both property tax revenue and the support for consumer spending that is provided by household wealth.

Ongoing Efforts to Help Struggling Borrowers
Given the high cost of foreclosures to everyone involved--lenders, investors, borrowers and their communities alike--it is in everyone's interest to develop prudent loan modification programs and provide for other assistance to help borrowers avoid preventable foreclosures. Indeed, policymakers and stakeholders have been working hard to find effective responses to the increases in delinquencies and foreclosures. The steps that have been taken so far include initiating programs designed to expand refinancing opportunities and efforts to increase the pace of loan workouts.

One example of positive steps being taken is the effort by NeighborWorks America and the Homeownership Preservation Foundation to offer financial counseling services through the Homeowner's HOPE Hotline.¹ With the encouragement and leadership of the Treasury Department, the national Hope Now Alliance--a broad-based coalition of government-sponsored enterprises (GSEs), industry trade associations, counseling agencies, and mortgage servicers--is working to find ways to help troubled borrowers, particularly those facing interest rate resets, through loan modification plans.² Recent actions by the Federal Open Market Committee to lower the target federal funds rate and resulting decreases in short-term interest rates also should help mitigate the problems associated with interest rate resets.

Useful steps also are being taken by the FHA, which provides insurance on a variety of fixed- and variable-rate mortgage products that can be used by borrowers who want to refinance their home and who meet specified underwriting and other criteria. For example, the agency recently established the FHASecure plan to help borrowers who are delinquent because of an interest rate reset and who have some equity in their home. FHASecure provides such borrowers the opportunity to refinance into an FHA-insured mortgage. Separately, the FHA's loan limits recently were raised significantly by the Economic Stimulus Act of 2008, further expanding the potential reach of the FHA's mortgage insurance programs. We understand that the FHA is studying additional ways that the agency's insurance programs could be expanded or modified, consistent with existing statutory authorities, to better help troubled borrowers.

The Federal Reserve has been working with financial institutions and community groups around the country to address the challenges posed by problem loans. For example, we have been providing community coalitions, counseling agencies, fellow regulators, and others with detailed analyses that identify neighborhoods with especially high concentrations of foreclosures. Last week the Federal Reserve made available to the public a set of dynamic maps and data that illustrate the regional variation in the condition of securitized, owner-occupied subprime and alt-A mortgage loans across the United States.³ Armed with this information, community organizations and leaders can better target their scarce resources toward helping borrowers in the greatest need of counseling and for other interventions that may help prevent foreclosure.

Communities also are searching for ways to address the challenges that foreclosed homes can present, such as decreased home values and vacant properties that can deteriorate from neglect. Toward this end, the Federal Reserve has recently engaged in a partnership with NeighborWorks America to identify effective strategies to stabilize neighborhoods that have large clusters of vacant properties due to foreclosures. Working together, we will develop materials and tools as well as convene training sessions to help communities build local capacity for acquiring and managing vacant properties. The ultimate goal is to return these properties to useful purposes, whether it is to provide affordable rental housing or to supply new homeownership opportunities in low- and moderate-income communities.

Loss-Mitigation Strategies to Reduce Foreclosures
In cases where it is not possible for the distressed mortgage borrower to refinance his or her mortgage into a more sustainable mortgage product, the next-best solution may be some type of loss-mitigation arrangement between the lender or servicer and the distressed borrower. The Federal Reserve, in conjunction with the other federal banking agencies (which include the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision), the Conference of State Bank Supervisors and the National Credit Union Administration, has issued guidance urging lenders and servicers to pursue such arrangements, when feasible and prudent, as an alternative to foreclosure. For the lender, servicer, and investor, working out a distressed loan with a struggling borrower makes economic sense if the net present value (NPV) of the payments under a loss-mitigation strategy exceeds the NPV of proceeds that would be received in foreclosure.

Loss mitigation can be advantageous to both the borrower and the lender because the costs associated with foreclosure can be very substantial. Historically, the foreclosure process has usually taken from a few months up to a year and a half, depending on state law and whether the borrower files for bankruptcy. Anecdotal evidence suggests that the time to complete a foreclosure has been increasing recently, as the number of foreclosures has risen and the average time that properties remain on the market has lengthened. The losses to lenders and investors from foreclosures include not only the missed mortgage payments during that period, but also the costs of taxes, legal and administrative fees, real estate owned sales commissions, and maintenance expenses. Additional losses arise from the often significant reduction in value when a property is repossessed even in stable housing markets, particularly if the property is unoccupied for some period. In fact, a recent estimate based on subprime mortgages foreclosed in the fourth quarter of 2007 indicated that total losses exceeded 50 percent of the principal balance. Whether the losses are that large in all cases is difficult to know, but what is known is that the foreclosure process itself destroys considerable value. The existence of such costs raises the real prospect that, by restructuring distressed loans in those cases in which the borrower wants to stay in the home, borrowers, lenders, servicers, and investors may all be able to achieve a better outcome than is attainable if the foreclosure process is allowed to run its course.

Lenders, servicers, and investors have historically relied on repayment plans as their preferred loss-mitigation technique. Under these plans, delinquent borrowers typically repay the mortgage arrears over a few months in addition to making their regularly scheduled mortgage payments. These plans often are most appropriate if the borrower has suffered a reversible setback, such as a temporary illness. However, anecdotal evidence suggests that even in the best-case scenarios, borrowers given repayment plans redefault at a high rate, especially when the arrears are large.

Loan modifications, which involve any permanent change to the terms of the mortgage contract, may be preferred when the higher payments associated with a repayment plan do not result in a sustainable solution. In a loan modification, the borrower's monthly payment is reduced through a lower interest rate, an extension of the maturity of the loan, a write-down of the principal balance, or a combination of all three of these measures. The effort by the Hope Now Alliance to freeze interest rates at the introductory rate for five years for eligible borrowers with an adjustable-rate mortgage is an example of a modification, in this case applied to a class of borrowers.

To date, permanent modifications in this credit cycle episode, as in the past, have typically involved a reduction in the interest rate or an extension of the loan terms, while reductions of principal balance have been quite rare. But the current housing difficulties differ from those in the past, largely because of the pervasiveness of situations known as negative equity positions in which the amount owed on the mortgage exceeds the current market value of the property. A distressed borrower with a negative equity position may have neither the means nor the incentive to remain in the home. In this environment, servicers and investors may well find principal reductions that restore some equity for at-risk homeowners to be an effective means of avoiding delinquency and foreclosure.

Although principal write-downs may be especially germane today given the prevalence of negative equity positions, they are not necessary or appropriate for all borrowers who have negative home equity or who become delinquent on their mortgage. On the contrary, a strategy of targeting write-downs to certain groups of borrowers may provide the best path forward. For example, one possibility would be to limit the availability of write-downs to those borrowers with high debt payment-to-income ratios and loan-to-value ratios significantly in excess of 100 percent before loan modification, but with the capacity to carry a written-down mortgage. In any event, it seems clear that principal reductions should be part of the tool kit that servicers and investors bring to bear as they deal with delinquent loans.

Additional Actions That Could Help Reduce Avoidable Foreclosures
Several steps could be taken to provide further impetus to loan modifications, including principal write-downs, in appropriate circumstances. One such step that could be taken relatively quickly by the industry is the development of a template that would guide servicers and others as they consider whether, and under what circumstances, to pursue various types of loan modifications, including principal write-downs. Enhanced guidance on loan modifications could help forge a common understanding among servicers and the investor community on when a particular loan modification tool is most appropriate. This guidance would help address the concern expressed by servicers that expanding the rate of principal reductions may expose them to increased litigation risks even in situations where the servicer reasonably determines that such action is beneficial to investors in comparison to other available options. The Hope Now Alliance organized by the industry and the Treasury Department successfully created guidelines dealing with interest rate resets. Leadership also is needed to provide guidance for other loan modification tools and to clarify the "best practices" to be followed by servicers in order to mitigate servicers' litigation risks.

The Congress can take another important step to facilitate greater use of loan modifications by moving quickly to reconcile and enact FHA modernization legislation permitting the FHA to increase its scale and improve the management of potential risks borne by the government. Such legislation could improve the FHA's ability to reach a wider range of borrowers while allowing the agency to develop appropriate underwriting and pricing methodologies for any increased risks assumed.

Separately, the GSEs--Fannie Mae and Freddie Mac--could be asked to do more. Recently, the Congress has greatly expanded Fannie Mae's and Freddie Mac's role in the mortgage market by temporarily increasing the conforming loan limits for these GSEs. In addition, their federal regulator, the Office of Federal Housing Enterprise Oversight, has lifted some of the constraints that were imposed on these entities because they have resolved some of their recent accounting and operational problems. Thus, now is an especially appropriate time to ask the GSEs to move quickly to raise more capital, which they will need to take advantage of these new securitization and investment opportunities, to provide assistance to the housing markets in times of stress, and to do so in a safe and sound manner. As the GSEs expand their roles in our mortgage market, there is a strong need for the Congress to move forward on GSE reform legislation, including the creation of a world-class GSE regulator. As the Federal Reserve has testified on many occasions, it is very important for the health and stability of our housing finance system that the Congress provide the GSE regulator with broad authority to set capital standards, establish a clear and credible receivership process, and define and monitor a transparent public purpose--one that transcends just shareholder interests--for the accumulation of assets held in their portfolios.

Desirable Characteristics of an Initiative to Encourage Loan Workouts
Going beyond the current proposals for FHA modernization and permitting the FHA greater latitude to set underwriting standards and risk-based premiums for mortgage refinancing--in a way that does not increase the expected cost to the taxpayer--would allow the FHA to help more troubled borrowers. For example, an FHA-insured refinancing product with insurance priced to reflect the risks to the taxpayers might encourage servicers to consider providing delinquent, at-risk mortgage borrowers a principal write-down as a loan modification alternative. The draft FHA Housing Stabilization and Homeownership Retention Act of 2008 includes provisions designed to allow the FHA to offer such products, which could be a useful tool in helping reduce preventable foreclosures.

As you move forward in considering whether to enact a bill and, if so, what its precise design should be, it will be important to consider a wide range of issues. In many cases, a judgment must be made as to how to strike an appropriate balance among competing considerations. Among the issues you will have to consider are at least the following five:

1. Mitigating moral hazard. Homeowners who can afford to pay their current mortgage should not be encouraged to default in order to qualify for a write-down. To discourage borrowers who would otherwise have the ability to continue making their payments from becoming delinquent, a variety of steps could be taken. For example, eligibility for assistance under the program could be restricted to borrowers who had relatively high debt payment-to-income ratios at some specified date before the creation of the program. In addition, steps could be taken to make it costly for homeowners who attempt to quickly cash-in on the equity provided through a principal write-down. For example, participating borrowers could be required to pay an exit fee when the refinancing loan is extinguished. As another example, borrowers could be required to share with the government or with the holder of the borrower's existing mortgage either the equity created through a write-down or the future appreciation in the home price, or both, over some specified time period. In other words, the government or investor would have what is known as a "soft-second." In addition, programs that provide for the voluntary participation of lenders and servicers should provide a natural brake on moral hazard, as lenders and servicers would remain free to pursue other options available to them in situations where they believe the borrower has the ability to repay his or her existing mortgage.

2. Mitigating adverse selection. A robust defense against adverse selection--the incentive of current servicers or lenders to send only their worst credits to the government-insured mortgage program--is necessary to protect the interests of the taxpayer. Mechanisms that would discourage adverse selection include: (i) a loan seasoning requirement (for example, a period during which the new loan could be sent back to the original servicer/lender if it redefaults) and (ii) a fee structure that imposes costs on the servicer/lender if the new government-insured loan goes bad within a specified period or pays a bonus if the loan continues to perform over the whole of that period.

3. Turning the FHA into a world-class mortgage insurer. With modernization and expansion, the FHA could play an important role in relieving stress in the mortgage and housing markets as well as in restarting securitization markets. Securitization markets are needed to help relieve capital stresses on banks and to provide more affordable mortgages to borrowers. To this end, more consideration needs to be given to how the FHA can scale up quickly and improve its processes and underwriting systems so that they are comparable in quality with those currently being used by Fannie Mae and Freddie Mac. In addition, providing the FHA with broad authority to offer innovative products that meet market needs and to outsource loan underwriting and other program elements to private-sector providers could allow the FHA to insure more mortgage borrowers and to do so more quickly. The FHA needs to be better able to compete in today's marketplace and it needs access to the best risk-management tools available when managing the risks to the government.

4. Protecting the taxpayer. Any government-insured mortgage offered under a refinancing program needs to be prudently underwritten, regardless of whether a principal write-down is part of the deal. First and foremost, this means establishing a meaningful amount of homeowner equity. Second, it means using sound underwriting criteria to ensure that borrowers are reasonably likely to be able to repay the government-insured loan on a sustained basis. Third, it means allowing the FHA to engage in sensible risk-based pricing of its mortgage insurance products, including substantial flexibility in setting its initial premium and annual premiums.

5. Negotiating junior liens. From one-third to one-half of all subprime mortgages pertain to properties that also have junior liens. When held by an entity other than the first lien holder, these junior liens present a variety of serious obstacles to a successful refinancing, especially one involving a principal write-down. Typically, the junior lien holder must agree either to remove his lien in return for a portion of the proceeds from the refinancing or re-subordinate his claim to the new loan. The valuation of the junior lien holder's claim on the property is often difficult to negotiate. One way of dealing with this problem in the case of a restructuring with an FHA-insured mortgage is to offer a junior lien holder a specified share of the government's or investor's "soft second." Another way of dealing with junior liens is to provide the servicer with financial incentives to aggressively negotiate with the junior lien holder while capping any potential payout available to the junior lien holder from the government program.

Elements of these considerations are already reflected in the discussion draft. For example, Title I of the discussion draft includes exit fees and shared appreciation mortgages to address concerns about borrower moral hazard. It also contains features to protect the taxpayer, such as widening the range of insurance premiums and creating a meaningful amount of borrower home equity. As for adverse selection, risk-based insurance premiums paid by the servicer are crucial, and Title I could be clearer about the FHA's authority to use risk-based premiums. Other steps to guard against adverse selection could include a loan seasoning requirement or other forms of warranties given by the lender to the government about loan performance.

Given the magnitude of the potential foreclosures on the horizon, more steps should be taken to modernize the FHA and to deal with the junior lien holders. The FHA needs the resources and the incentives to manage the risks to the government well and to offer mortgage insurance products that will be attractive to servicers. As for junior lien holders, despite the government's best efforts, it may be difficult for servicers or lenders to negotiate with junior lien holders on the borrowers' behalf. The FHA needs substantial flexibility to provide incentives to servicers to negotiate with junior lien holders to address this difficult problem.

The Congress may be concerned that the loan-by-loan approach could prove insufficient. Title II of the discussion draft would permit substantial flexibility to expand the program if needed by introducing a bulk-refinance mechanism if economic conditions warrant such action. This mechanism would rely on an auction-based process to price and deliver mortgages for refinancing. Note that an auction-based approach would still have to contend with some of the problems mentioned above, including moral hazard, adverse selection and the resolution of junior liens. Title II would grant authority to the implementing agencies to build in features needed to address these and other issues. If you move forward with this legislation, it will be important that the implementing agencies have full latitude to exercise such authority.

In the design and details of a principal write-down program based on a government-insured refinancing, it is critical to strike the right balance between the interests of borrowers, servicers, investors, and taxpayers. For example, the larger the required principal reduction on a troubled loan, the fewer loans that lenders or servicers will offer voluntarily for refinancing into an FHA-insured product, thereby reducing the "take up" rate for the program. However, a larger principal write-down better protects taxpayers from future losses and gives the borrower a greater incentive to stay current on the refinanced mortgage.

As another example, the more incentives given to servicers to use an FHA refinancing program, either through direct payments or through shared appreciation agreements, the more they would be willing to incur the costs of refinancing borrowers. Such incentives might increase the number of borrowers who might be considered for a government-backed program. But such incentives also would raise the cost of the program for the borrower and possibly for the government as well.

As a final example, providing investors with some of the benefits of any shared-appreciation agreements might encourage them to allow servicers to write down principal and refinance borrowers into a government-backed program. However, providing the government with such agreements could be one means of compensating taxpayers for shouldering the risks associated with the program.

Even if the right balance for the program can be struck, obstacles remain to the successful implementation of a government program designed to forestall preventable foreclosures. For example, even though workouts may often be the best economic alternative, mortgage securitization and the constraints faced by servicers may make such workouts less likely. Trusts vary in the type and scope of modifications that are explicitly permitted, and these differences raise operational compliance costs and litigation risks for the servicer. So that servicers do not try to unduly avoid litigation risks, leadership is needed to clarify their duties.

Conclusion
FHA modernization and GSE reform are needed to address the ongoing shortcomings of current mortgage-oriented government initiatives. In addition, the GSEs should be strongly encouraged to raise additional capital so that they can fulfill the expanded role that the Congress has recently extended to them.

Separately, the Congress should carefully evaluate whether to take additional actions to reduce the rate of preventable foreclosures. Properly designed, such steps could promote economic stability for households, neighborhoods, and the nation as a whole. Although lenders and servicers have scaled up their efforts and have adopted a wider variety of loss-mitigation techniques, more can, and should, be done.

The fact that many troubled borrowers have properties that are now worth less than the principal amounts remaining on their mortgages suggests that lenders and servicers should give greater consideration to the use of principal reductions as one of the loan modification options in their tool kit. Principal write-downs would be facilitated by providing the FHA the flexibility to insure a broad range of refinancing products for a larger number of at-risk borrowers, including products that offer borrowers an affordable, restructured mortgage if their lender voluntarily agrees to write-down the principal amount of the borrower's mortgage. The voluntary nature of the program assures that only borrowers who the servicer or lender believes cannot successfully carry their current mortgage contract would be considered for such a program. If the Congress decides to move down this road, it should carefully consider the steps that should be taken to mitigate moral hazard, avoid adverse selection, and ensure that the financial interests of the taxpayer are adequately safeguarded.

Footnotes

1. The telephone number for the nationwide Homeowner’s HOPE Hotline is 888-995-HOPE. Return to text

2. Hope Now is an alliance between counselors, mortgage market participants, and mortgage servicers to create a unified, coordinated plan to reach and help as many homeowners as possible. For more information see: www.hopenow.com. Return to text

3. The maps show data for each state and for most counties and zip codes. They are available on the website of the Federal Reserve Bank of New York. Return to text

• Northeast: rose 3.2 percent in February to 71.8 but remains 25.4 percent below a year ago.
• Midwest: declined 3.7 percent to 82.7 and is 17.4 percent lower than February 2007.
• South: fell 5.5 percent in February to 85 and is 30.3 percent below a year ago.
• West: dropped 9.8 percent in February to 84.6 and is 17.1 percent below February 2007.

• Mortgage rates: 30-year fixed-rate mortgages, which has fluctuated recently, should average 5.8 percent in the second and third quarters, but trend up to an average of 6.3 percent in 2009.

• Growth in the U.S. gross domestic product: expected to be 1.4 percent in 2008 and 2.4 percent next year.

• Unemployment rate: forecast to average 5.4 percent this year and 5.6 percent in 2009.

• Inflation: (as measured by the Consumer Price Index) is projected at 3.4 percent in 2008 and 2.2 percent next year. Inflation-adjusted disposable personal income is likely to grow 1.2 percent this year and 3.0 percent in 2009.

Greenspan Blames Investors for Slump

Former Federal Reserve chairman Alan Greenspan refutes reports that monetary policy exacerbated a housing bubble that led to the current crisis in the financial markets.

Although the central bank lowered interest rates to 1.0 percent in 2003 from 6.5 percent in 2000 under Greenspan's watch, he insists that sluggish economic conditions in mid-2003 indicate that monetary policy did not create the bubble.

In a Financial Times piece, Greenspan says investors are responsible for the subprime mortgage crisis; and he notes that they snapped up mortgage-backed securities without paying attention to quality. He adds, "The problem is not the lack of regulation but unrealistic expectations about what regulators are able to prevent."

Source: Reuters, Jeremy Gaunt (04/07/08)

Canadians Seek U.S. Vacation-Home Deals

Canadians – especially those who live in U.S. border areas – are snapping up vacation homes in the U.S. as the Canadian dollar gains value against the declining American dollar.

Developers in the finger lake areas of Washington State say more than 80 percent of buyers are Canadian. "The Canadians are just running out of space, and affordable space at that, so it's driving them across the border," says Chris Branch, city planner for Oroville, Wash.

The largest number of Canadians seeking U.S. property head to Florida. California was second in popularity, according to a survey by the NATIONAL ASSOCIATION OF REALTORS®.

How can you capitalize on Canadian buyers? Greg Moesser, estates director at Prudential California Realty in Beverly Hills, says a strong Internet presence with an international flair is crucial because Canadians frequently familiarize themselves with U.S. housing markets online before they search for a specific property in person.

Source: The Associated Press, Shannon Dininny (04/04/2008) and The Los Angeles Times, Marcie Geffner (03/23/2008)

Making Your Real Estate Offer

When you find the right home, what can you do to maximize your chances of actually getting it? The first step you should take is to make a prompt offer.

Whether you are in a buyers' or sellers' market, taking too much time to initiate an offer can cost you money, especially if you are planning to offer less than the asking price or will be asking for special terms. If your offer is the only one on the table, the sellers will consider it, and if they don't accept it, they may make a good counter offer. While you are "sleeping on it", however, you risk the possibility of another offer coming in. If another buyer appears on the scene, you lose an important advantage while you and the sellers are going back and forth with offers and counter offers. A buyer who really wants that special house will make the best possible offer --as quickly as possible.

Real Estate Negotiating Factors

Negotiations for the sale of a home can be affected by emotional factors. For example, it is easy to be offended by someone who is making an offer on your property. Even if the buyers love your house, they are trying to negotiate the best possible price and terms. They probably will not let you know how much they want your home until they have negotiated a purchase agreement.

Buyers almost never write offers that please the sellers entirely. Offers and counter offers may be traded back and forth over days or weeks. Terms of the sale will be discussed and deadlines will be set. When there is finally a meeting of the minds, both sides may feel relieved but exhausted by the process. One of a real estate agent's most important jobs is to act as the intermediary during such negotiations. With your agents knowledge of financing, negotiation procedures, and the tax laws affecting real estate sales, agents come up with creative solutions to the challenges that may arise.

Real Estate Negotiations Part 2

If you are the buyer in a home sale transaction, you should be prepared to submit an offer to the seller. An offer is not simply the price -- there are more components involved.

The real estate agent will act as the conveyor of information. There are a few things to look out for in such negotiations: 1) include a finance contingency, even if you have loan pre-approval, 2) insist on an engineer's, termite and radon inspection contingencies, 3) itemize the personal property you want included, such as chandeliers or drapes, and 4) submit the closing date you prefer.

Buyers should be prepared to make their best offer first, but if that offer is not acceptable to the seller, they should expect to go through a round of counter-offers.

7 money 'rules' you can ignore

Buying Bank Owned

Buying at Auction

7 ways to win the customer-service game

25 companies where customers come first