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Fed Chair Rethinks Easy Access To Credit

By Martin H. Bosworth
ConsumerAffairs.com

March 30, 2007

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Federal Reserve chairman Ben Bernanke recently commented that widespread access to credit may have contributed to the chain of events leading to the explosion in home prices and the subsequent implosion of lenders that cater to the "subprime" market.

Bernanke's comments came as part of a speech touting the benefits of the Community Reinvestment Act (CRA), which insures that banks and lenders in a community provide services to low-income residents. The CRA was generally credited for helping families with low and moderate income levels achieve homeownership in greater numbers than before, but that the "results were not uniform," Bernanke said.

Increased participation of nonbank lenders in the mortgage market and the expansion of available credit -- along with a corresponding relaxation of standards for lending -- also increased home ownership for many who might not have been able to purchase a first home otherwise. But, Bernanke cautioned, "recent problems in mortgage markets illustrate that an underlying assumption of the CRA -- that more lending equals better outcomes for local communities may not always hold."

"Whether, and if so, how to try to differentiate "good" from "bad" lending in the CRA context is an issue that is likely to challenge us for some time," Bernanke said. "One possible strategy is to place more weight in CRA examinations on factors such as whether an institution provides services complementary to lending--for example, counseling and financial education."

The collapse of the subprime market -- lenders who target loans at individuals with low incomes, or with bad or minimal credit histories -- has accelerated as home sales stall, prices sag, and families find themselves trapped in homes they can't afford and can't easily sell or refinance. Many homebuyers took advantage of "creative" mortgage products, such as interest-only loans, with ballooning payments that the borrower can't keep up with.

Many subprime lenders took advantage of the hot market by loosening underwriting standards and overlooking problems in a borrower's financial history. Others deliberately targeted low-income markets -- mostly black and Hispanic -- and used predatory lending tactics, as well as capitalizing on the lack of financial education of many borrowers.

As homeowners defaulted on their loans in increasing numbers, and many simply let their homes be foreclosed, subprime lenders found themselves unable to finance new loans and fend off hungry backers. New Century Financial is potentially seeking bankruptcy protection after agreeing to cease lending practices in several states, and has cut ties with mortgage backers such as Freddie Mac.

States and Congress alike have been calling for tighter regulation of mortgage lenders, especially in the subprime market, and more aggressive prosecution of companies that engage in predatory lending tactics. Senator Charles Schumer (D-NY) recently offered up new legislation that would empower a "national regulatory system" to oversee all lenders and prevent proliferation of no-document loans.

Bernanke's Burden

Meanwhile, Fed chair Bernanke continues to navigate through an economic bust engineered in no small part by his predecessor, Alan Greenspan. The former Fed chair's decision to cut interest rates to record lows spurred new trends in lending and borrowing, as homeowners refinanced multiple times, pulled equity out of their homes, and "speculated" in the market by buying multiple properties to "flip" for quick profits.

It was not until Greenspan was safely retired that he began to warn of the ill effects of easily available credit in the housing boom.

After two years of raising the prime lending interest rate during his tenure, Bernanke's Fed has held lending rates steady at 5.25 percent while campaigning for Congress to address fixing entitlement programs such as Medicare and Social Security.

Bernanke has frequently stated that failures in the subprime market would be "contained" and would not spread to the larger mortgage sector, and that the economy would grow at a sustainable pace, not requiring further hikes in interest rates. His "easy credit" comments are the strongest indicator yet that the Federal Reserve may change its course, possibly pushing for tighter lending standards to prevent future meltdowns.

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