Privately-owned housing starts in February 2012 were at a seasonally adjusted annual rate of 698,000. This is 1.1 percent (+/- 15.9%)* below the revised January 2012 estimate of 706,000.

February 2012: -1.1 % change
January 2012: +3.7 % change

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Testimony before the Committee on Government Oversight and Reform, U.S. House of Representatives, Washington, D.C.

Testimony before the Committee on Oversight and Government Reform, U.S. House of Representatives, Field Hearing, Brooklyn, New York

Speech at the At the Independent Community Bankers of America National Convention and Techworld, Nashville, Tennessee

Speech at the Y’s Men and Y’s Women of Westport, Westport, Connecticut

Testimony before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C.. Chairman Bernanke presented identical remarks before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate on March 1, 2012

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Speech at the Future of Community Banking Conference, sponsored by the Federal Deposit Insurance Corporation, Arlington, Virginia

Speech at the 2012 National Association of Homebuilders International Builders’ Show, Orlando, Florida

Testimony before the Committee on the Budget, U.S. House of Representatives, Washington, D.C.. Chairman Bernanke presented identical remarks before the Committee on the Budget, U.S. Senate on February 7, 2012

Testimony before the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Testimony before the Subcommittee on Capital Markets and Government Sponsored Enterprises and the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Speech at the Robins School of Business, Robins Executive Speaker Series, University of Richmond, Richmond, Virginia

Speech at the Federal Reserve Conference on Central Banking: Before, During, and After the Crisis, Washington, D.C.

Sales of new single-family houses in February 2012 were at a seasonally adjusted annual rate of 313,000. This is 1.6 percent (+/- 23.9%)* below the revised January 2012 estimate of 318,000.

February 2012: -1.6 % change
January 2012: -5.4 % change

Speech at the Fourteenth Annual International Banking Conference, Federal Reserve Bank of Chicago, Chicago, Illinois

Speech at the Town Hall Meeting with Soldiers and and Their Families, Fort Bliss, Texas

Speech at the Clearing House Business Meeting and Conference, New York, New York

Speech at the Conference on Small Business and Entrepreneurship during an Economic Recovery, Federal Reserve Board, Washington, D.C.

Speech at the American Bar Association Banking Law Committee Fall Meeting, Washington, D.C.

Speech at the 2011 Virginia Beach Financial Planning Day, Virginia Beach, Virginia

Speech at the 2011 Annual Meeting of the Financial Management Association International, Denver, Colorado

Speech at the World Leaders Forum, Columbia University, New York, New York

Speech at the Federal Reserve Bank of Boston 56th Economic Conference, Boston, Massachusetts

Testimony before the Joint Economic Committee, U.S. Congress, Washington, D.C.

Speech at the Maryland State Bar Association Advanced Real Property Institute, Columbia, Maryland

Speech at the Cleveland Clinic "Ideas for Tomorrow" Series, Cleveland, Ohio

Speech at the University of Maryland Smith School of Business Distinguished Speaker Series, Washington, D.C., D.C.

Speech at the Conference on the Regulation of Systemic Risk, Federal Reserve Board, Washington, D.C.

Speech at the Conference on the Regulation of Systemic Risk, Federal Reserve Board, Washington, D.C.

Speech at the Federal Reserve Board Policy Forum: "The Housing Market Going Forward: Lessons Learned from the Recent Crisis", Washington, D.C.

Speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming

Statement provided to the Subcommittee on Financial Institutions and Consumer Credit, Committee on Financial Services, U.S. House of Representatives, Newnan, Georgia

Testimony before the Subcommittee on Oversight and Investigations, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Testimony before the Subcommittee on Insurance, Housing, and Community Opportunity, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Testimony before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C.. Chairman Bernanke presented identical remarks before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate on July 14, 2011

Statement provided to the Subcommittees on Financial Institutions and Consumer Credit and Oversight and Investigations, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Speech at the New America Foundation Forum, Washington, D.C.

Testimony before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Testimony before the Subcommittee on Financial Institutions and Consumer Protection, Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Testimony before the Committee on Agriculture, Nutrition, and Forestry, U.S. Senate, Washington, D.C.

Speech at the Annual Conference of the Committee for a Responsible Federal Budget, Washington, D.C.

Speech at the 2011 Federal Reserve Bank of Cleveland Policy Summit, Cleveland, Ohio

Speech at the International Monetary Conference, Atlanta, Georgia

Friday’s bond market has opened in helpful territory as investors look to close the year out on a encouraging note. The stock markets are showing minor losses of 18 points in the Dow and 11 points in the Nasdaq. The bond market is currently up 10/32, which should improve this morning’s mortgage interest rates by approximately .125 of a discount point.

There is nothing of importance this morning, making it highly likely that we will crawl into the end of the year. As expected, trading is extremely light this morning and there is no reason to think that will change before today’s 2:00 PM ET close. The stock markets are technically open all day, but it doesn’t look many traders went to work. We will probably see a little fluctuation in the major indexes and bond prices, but I would be highly surprised if we saw significant movement or an intra-day change to mortgage interest rates.

Next week brings us the release of several relevant monetary reports. The week opens and closes with important reports, giving us a good look at current financial conditions. Monday has December’s Institute for Supply Management’s manufacturing index. This is usually the first most current report we see month. It is posted the first business day of the month and covers the preceding month. The data tracks manufacturer sentiment, giving us an indication of manufacturing sector strength. It is considered to be one of the more important reports we see each month.

The week closes next Friday with the almighty monthly Employment report. In between the Institute for Supply Management index and Employment numbers there are a couple more events scheduled, including the minutes from the past FOMC meeting and a couple of less important trade and industry reports. Late in the week, Fed Chairman Bernanke will speak, drawing the close attention of the markets also. I am actually looking forward to some of this key data as I still believe December’s spike in interest rates was an overreaction. I suspect we will still results that remind us we still have significant hurdles facing the economy and this month’s optimism was premature. If this is the case, we should see mortgage interest rates move lower next week.

Look for more details on next week’s events in Sunday’s weekly preview. I would like to take this opportunity to wish everyone and theirs a wonderful and safe holiday weekend and a prosperous new year!

If you are considering financing/refinancing a home, I would…. Lock if your closing takes place within 7 days… Float if your closing takes place between 8 and 20 days… Float if your closing takes place between 21 and 60 days… if your closing takes place over 60 days from now…

Daily Rate Lock Advice for 12/30/2011

Thursday’s bond market has opened in depressing territory following the release of much stronger than expected trade and industry data. The stock markets have had little answer to the news with the Dow up 9 points and the NASDAQ down 2 points. The bond market is currently down 9/32, but we will still see a noticeable step up in this morning’s mortgage interest rates due to strength late yesterday. If comparing to yesterday’s morning interest rates, we should see an increase of approximately .375 of a discount point.

The Labor Department said early this morning that 388,000 new claims for joblessness reimbursement were filed last week. This was well below forecasts of 416,000 and the lowest total since July 2008. At first appearance, the headline number could be concerning for the bond market and good news for stocks. The size of the drop and the number of new claims hints at a strengthening employment sector. In fact, the number of weekly new claims has risen only once in the past 6 weeks.

That said the markets have not had a significant reaction to the data for a couple of reasons. First and primarily, the data covers only a single week’s worth of new claims. Another portion of the report showed that the number of continuing claims for reimbursement (claims that are not new) rose during the week when analysts were expecting them to remain flat. Also, the reason for the drop in new claims could be the Christmas Holiday last week where state offices were closed at least one of the five days. So, while the headline number of 388,000 does draw attention, it comes from a report that does not carry significant importance because of the short term it covers and were statistics from a holiday-shortened week.

We saw bonds rally late in the day yesterday, partly as a result of a 7-year Note auction that went surprisingly well. Several of the measurements we use to gauge the success of the auctions showed fairly strong investor demand, especially if comparing to Tuesday’s 5-year Note sale. After the results of yesterday’s sale were posted, bonds moved higher causing some lenders to revise mortgage interest rates lower.

There is no relevant monetary data scheduled for release tomorrow. It is the last trading day of the year, so we may see a little unpredictability as investors look to finalize their year-end holdings. We may actually see some of that take place this afternoon, so don’t be surprised to see movement in the markets this afternoon. But there is not much disquiet that we will see sizable changes to mortgage interest rates. Keep in mind that the bond market will close at 2:00 PM ET tomorrow and will reopen Monday for regular hours. The stock markets will not be recognizing the holiday with regular trading hours both tomorrow and Monday.

If you are considering financing/refinancing a home, you should…. Lock if your closing takes place within 7 days… Lock if your closing takes place between 8 and 20 days… Float if your closing takes place between 21 and 60 days… Float if your closing takes place over 60 days from now…

Regulatory Changes in Consumer Credit and Payments

In addition to the economic recession and recovery, the regulations governing consumer payment and credit products changed significantly in the past few years. So it is especially difficult to separate the effects of economic conditions from regulatory effects on credit and debit card usage.

In December 2008, the Federal Reserve issued rules that introduced new consumer protections and revised the disclosures that consumers receive in connection with their credit card accounts. Then, in May 2009, the Congress enacted the Credit Card Accountability Responsibility and Disclosure (Credit CARD) Act, which contained additional provisions regarding credit cards and gift cards. Collectively, these rules have comprehensively overhauled the regulatory regime that applies to credit cards.

In large part, these reforms developed in response to concerns about the growing complexity of the products offered to consumers and concerns that consumers could not accurately assess the costs associated with their credit cards. To address these concerns, the Federal Reserve used extensive consumer testing to develop new disclosures to be provided with credit card solicitations and in periodic statements. These disclosures highlight key account terms and attempt to improve consumers’ understanding of the costs associated with using their cards. The resulting disclosure requirements establish a new baseline for transparency in the credit card industry. In addition, the new rules ban certain practices that increase the cost of credit in ways that cannot easily be disclosed to consumers, such as double-cycle billing. The new rules also generally prohibit card issuers from increasing interest rates applied to existing balances and require issuers to provide adequate notice of higher rates to be applied to future balances.

It is too early to draw conclusions about the ultimate impact of these changes because many of the new requirements have been in effect only since earlier this year. For example, card issuers appear to have changed their credit card pricing and underwriting models as their ability to use penalty pricing has been reduced. And some of the reduction in new account solicitations may also be due in part to the regulatory changes. But, in light of the concurrent changes in charge-off rates, economic conditions, and regulatory requirements, it is hard to separate the relative effects of each.

One way to assess the effects of regulation alone might be to watch the relative developments in business credit cards in comparison to consumer credit cards. Credit cards issued primarily for business or commercial purposes generally are not governed by the consumer protections in the Truth in Lending Act or the amendments to that act in the 2009 Credit CARD Act. Some observers have already expressed concern that some card issuers may be marketing business and professional cards to consumers in an effort to sidestep new restrictions. At the same time, some business owners and professionals might find the higher credit line availability or other terms offered on business cards to be more attractive than using their personal cards for business expenses. The federal banking agencies have sufficient supervisory and enforcement authority to ensure that issuers market and issue business cards only to borrowers who they have legitimate reason to believe are using them for business purposes. Generally speaking, the card issuer is responsible for determining whether an account is intended to be used for business or personal purposes, and indeed, business card applications commonly request information necessary to make this determination. The detailed information requested may include, for example, the type of business, annual revenue, age of the firm, number of employees, and tax identification number. The answers to these questions help verify that the applicant owns a business, as well as gauge the creditworthiness of the business.

Aside from credit cards, the regulatory landscape is also changing for other payment products. The Federal Reserve has recently issued regulations that prohibit consumers from being automatically enrolled in overdraft programs for overdrafts created by automated teller machine withdrawals and one-time debit card transactions. In addition, new disclosures are required to help consumers understand the associated costs before they choose to opt into overdraft coverage. We have also implemented new protections under the Credit CARD Act that restrict the fees and expiration dates that apply to gift cards.4

The Dodd-Frank Wall Street Reform and Consumer Protection Act requires the Federal Reserve to develop standards for debit card interchange fees and the routing of debit card transactions. I am aware of the high level of interest in this topic, and I recognize the importance of the statute and its implementation for the future development of the payment card industry. However, we plan to issue a proposal for comment soon, so I will not comment on any specific elements at this time.

Just as credit card products have undergone change in response to the new credit card rules, new regulations affecting debit card overdrafts and interchange fees are likely to result in some changes in deposit product pricing and design. For example, depository institutions have stated that they are reconsidering their ability to offer free or low-cost checking accounts if losses due to lower revenue from overdraft or interchange fees materialize. As the pricing of checking accounts changes, financial institutions and consumers may turn to certain types of reloadable prepaid cards as checking account alternatives.

The Future of Consumer Credit and Payments

While the pace of the economic recovery and the effects of new consumer regulations are strongly influencing lender and consumer behavior, the evolution in the consumer credit and payments landscape in the years ahead will be equally shaped by technological innovation.

Innovative product and system design in the payment card marketplace continues to produce new electronic payment products. For example, a growing number of consumers are using prepaid cards. Preliminary estimates from the Federal Reserve Bank of Boston’s 2009 Survey of Consumer Payment Choice indicate that about one-third of consumers sampled reported having a prepaid card of some type.

Offering functionality similar to credit and debit cards, prepaid cards include a variety of products targeted to different groups of customers, from general-purpose reloadable cards that may serve as deposit account substitutes for the unbanked or the underbanked to more-limited-purpose products, such as gift cards, teen spending cards, or mass transit cards. In addition, as an alternative to checks, employers issue payroll cards to employees and numerous government entities make payments and issue benefits on cards. And of course, the idea behind prepaid cards is not limited to being in card form; their function also may show up in the form of codes, stickers, cell phones, and chips embedded in any number of other devices, with payments transferring across the debit card interchange system or automated clearinghouse systems. Depending on the card type, the issuer, the purpose of issuance, the payment collection network, and the form of access, payments made using prepaid cards or other devices may be governed by different regulations and interchange fee restrictions. Consumers cannot be expected to know these differences. It will be important for regulators to monitor, over time, the effect of differences in regulation and pricing restrictions to ensure that consumers are adequately protected regardless of their payment method preferences.

Other emerging payment methods, such as mobile payments, also show potential for broad adoption in the United States. Earlier this year, the Federal Reserve Board hosted a forum on consumer protection and education issues associated with mobile payment methods. The Reserve Banks, including the Reserve Bank of Philadelphia through the efforts of the Payment Cards Center, have also been active in soliciting information from industry participants on the roles that various players are taking on in U.S. mobile payments and the forces that are affecting the rate of adoption by card issuers, merchants, networks, telecommunication firms, consumers, and others. As of yet, mobile payments do not represent a meaningful percentage of overall consumer payments in the United States, but the Federal Reserve remains engaged in monitoring the emergence of this product to ensure that adequate consumer protections are put in place as the technology is adopted more broadly in the marketplace.

Changes in the Use of Payment Instruments

Consumer credit pricing and availability also appear to affect consumer preferences for different payment methods. When consumers decide how to pay for their purchases, they may have a variety of payment options to choose from, including cash, checks, debit cards, credit cards, prepaid cards, and even, increasingly, their mobile phones. The Federal Reserve has tracked changes in consumers’ use of payment instruments in a number of studies over the past decade. These studies cast an interesting light on the effects that weakened economic conditions have had on the mix of payments.

The number of checks processed in the United States has been declining since the late 1990s, as consumers, businesses, and governments have shifted away from checks and toward electronic payment methods. The annual number of checks dropped from more than 40 billion in 2000 to 30 billion in 2006, and we expect the data for 2009 to show continued declines.

At the same time, the use of debit and credit cards has risen. Debit card payments, in particular, have grown remarkably: Between 2000 and 2008, the number of debit card transactions grew at an annual rate of more than 17 percent, while the value of debit card transactions grew 15 percent per year. Credit card transactions have grown at a slower pace than debit card transactions over the same period–about 2 percent per year in number and roughly 5 percent per year in value. For smaller-value payments, both types of cards, but especially debit cards, have served as substitutes for checks and, very likely, cash. Although the nature of cash makes direct measurement of aggregate cash payments difficult, we can infer a trend in usage from changes in the level of small-denomination currency that is most frequently used in cash payments. The amount of small-denomination domestic currency in circulation has been steadily declining since the 1970s, leading us to believe that cash payments have similarly declined.

Most interestingly, the recent period of economic weakness appears to have caused some consumers to shift away from credit cards not only as a source of credit but also as a method of payment. As I said earlier, between late 2008 and early 2010, the value of credit card purchases declined 10 percent. In comparison, although the rate of growth in debit card use slowed during the recession, debit card transactions did not decline in either volume or value.

This shift from credit to debit makes sense from the perspective of the consumer. If credit is tight and consumption is contracting, consumers who are reluctant or unable to increase their debt levels can use debit cards to pay for current expenses out of current, rather than future, income. In addition, for individuals with existing credit card balances, interest must be paid on new purchases as well as on previous balances. Those individuals might seek to avoid interest charges on new purchases by using debit cards. This incentive is even stronger in the presence of higher credit card interest rates. Finally, some consumers might use debit cards to track their spending in real time when budgets are tight.

Changes in Consumer Credit
During the recent financial crisis, the Federal Reserve and other policymakers throughout the government took unprecedented actions to mitigate the fallout from severely distressed market conditions and support the flow of credit to consumers and businesses. Nonetheless, the level of credit outstanding for households has been very slow to rebound and remains lower than it was at the onset of the crisis. The reasons for the slow rebound are, without a doubt, complex and multidimensional. Still, it is worthwhile to examine the data and try to understand why credit growth is not more robust.

For this forum, I have chosen to focus my discussion on factors affecting the overall movements in credit card debt. The bulk of revolving credit in the United States today is held in the form of credit card debt. As the financial crisis developed in late 2008, the aggregate amount of credit card debt outstanding began to fall. Revolving credit has dropped every month since that time and is currently about 15 percent lower than it was at the time of the Lehman Brothers Holdings bankruptcy. Although our economy has experienced other long episodes in which revolving credit growth has slowed, we have never seen such a prolonged period of outright decline.

As overall consumer spending weakened significantly over the course of the recession and the early stages of the recovery, a proportionate decline in revolving credit used to finance purchases might actually have been expected. However, the decrease in revolving credit appeared to outpace the contemporaneous decline in spending during the recession, and, so far in the recovery, revolving credit has continued to decrease even as spending has turned up. This suggests that there are factors at work other than cyclical spending weakness. Within this context, it is helpful to consider the three main reasons that net borrowing–that is, the change in credit outstanding–can decrease: First, households can charge less on their revolving accounts; second, households can pay off a larger share of their balances each month; or third, households can default on (or lenders can charge off) their existing balances.

Taking the three factors in reverse order, consider first the role of cardholder defaults. As the economy weakened in 2008 and 2009, an increasing number of households found it difficult to pay their credit card bills on time. With nearly 10 percent of the workforce unemployed and many more underemployed, a significant number of households experienced sharply reduced incomes. Weakness in the housing market also contributed to financial strains, as many households could no longer easily tap into home equity to consolidate their card debt and lower their monthly payments.¹ In this adverse economic environment, it is perhaps not surprising that the charge-off rate on credit cards more than doubled from about 4 percent in 2007 to more than 9 percent in 2009. The rate of charge-offs has since declined from its peak but remains elevated. All told, we estimate that the rise in charge-offs can account for about one-third of the net decline in revolving credit growth from 2007 to 2009.

Another possible explanation for the decline in outstanding balances might be that households, in an effort to repair their balance sheets or bring down their debt burdens, have begun paying down their credit card balances faster than usual. But, on the whole, the data do not indicate that faster paydown is a significant factor. Historically, households tend to repay their credit card balances at a faster rate during good economic times and tend to slow this rate when economic activity is weak. And, over the past several years, this tendency appears to have held up. In 2006, the rate of credit card repayment was well above its long-run trend, probably reflecting strong incomes as well as ample home equity that could be tapped to pay off more expensive card debt. However, beginning in 2007, as housing markets weakened and unemployment climbed, households began to pay off their card debt at a significantly slower pace–a trend that extended into 2008 and 2009 as the economic downturn worsened. All told, the drop in the payoff rate has been more pronounced than in the recessions of 1990-91 and 2000-01. More recently, however, this trend has reversed, and as of August 2010, the repayment rate had risen to a more typical level. While this increase likely reflects a gradual improvement in the ability of cardholders to repay their debt, it could also be attributed to a shift in the composition of cardholders in bank portfolios toward more creditworthy borrowers as charged-off accounts were replaced with new accounts underwritten using stricter criteria. The bottom line is that accelerated payment rates on existing balances do not seem to have contributed importantly to the drop in credit card debt outstanding over the past couple of years.

Finally, consumers have been charging less on their credit cards. According to industry statistics, the amount of money charged on credit cards for purchases or cash advances fell around 10 percent between the third quarter of 2008 and the first quarter of 2010. This slowdown in new charges could be the result of a variety of factors. The significant overall drop in consumption during the recession no doubt cut into the demand for credit, as households simply opted to spend less than in the past. When they did spend, they may have been less willing to borrow to fund consumption given their experiences during the financial crisis, expectations for weaker economic conditions, and continued uncertainty about job prospects. Indeed, consumer preferences toward debt do appear to have shifted. Preliminary data from the 2007-09 Panel Survey of Consumer Finances (SCF) show a modest increase–from 35 percent in 2007 to more than 40 percent in 2009–in the share of households that believed that buying things on credit was a “bad idea.” Further, those households whose views about buying on credit became more negative between 2007 and 2009 reported reducing their charges substantially more than other households. Consumers also appear to be seeking less new credit: Applications for new credit accounts, as recorded in data from the national credit bureaus, remain significantly lower than were observed for most of the past decade.

Credit supply factors have also likely contributed to the decline in overall credit card outstanding balances. Households may have charged less because they had less credit available. In the SCF panel, about 44 percent of households with credit card debt in 2007 experienced a reduction in their credit limits by 2009. Data from the national credit bureaus indicate that credit lines peaked in the third quarter of 2008 and continued to fall over the course of 2009 and 2010. The average dollar value of combined credit lines available to cardholders fell from a high near $26,000 per cardholder in late 2008 to around $21,000 per cardholder by the third quarter of 2010, a decline of about 20 percent. Moreover, SCF data indicate that changes in credit limits are indeed related to credit card spending: Among households whose credit limit declined, SCF data show that the median amount of monthly new charges fell from $200 in 2007 to $50 in 2009, while among households whose credit limit did not decline, the median amount of new charges rose from $150 to $200. Although this relationship is not necessarily causal, credit line restrictions have likely played at least some role in the reduction in credit card borrowing.

Looking further at the supply side of credit card debt, card lenders did report retrenching during the financial crisis. According to the Federal Reserve Board’s quarterly Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), large fractions of banks tightened standards and terms on new and existing credit card accounts throughout 2008 and 2009.² In recent months, however, some banks reported having eased standards somewhat. In the most recent survey, published in October 2010, about two-thirds of banks thought that credit standards for prime borrowers on credit card loans and other consumer loans either were at their longer-run averages or would return to them over the next two years. In contrast, for nonprime borrowers, more than half of the respondents thought that standards would remain tighter through at least 2013 or would not return to longer-run norms for the foreseeable future.

In addition to reductions in existing credit lines, new credit card account solicitations also fell considerably during the recession. By early 2009, offers to households for new credit cards had dropped to around one-fifth of their count in 2006. Card solicitations have turned up over the course of 2010, but they remain well below their pre-crisis levels. In addition, consistent with the SLOOS, the data on credit card offers show that solicitations to borrowers with lower credit scores are rebounding more slowly than those to borrowers with higher scores.

Interest rates may have caused some households to reduce their credit card usage even if unused credit lines remained available. Although credit card interest rates declined in line with broader interest rates early in the financial crisis, card rates diverged from the broader rate environment by reversing this decline during 2009. Some of the rate increase likely reflects a rise in charge-offs, which increases card issuers’ costs of providing credit. However, the divergence from rates on other forms of credit that also experienced higher charge-offs indicates that a portion of the increase may have been in anticipation of regulatory changes, which I will discuss a bit later, that will restrict some card issuers’ ability to reprice credit.

Overall, then, the available data lead me to conclude that, in large part, the decline in revolving consumer credit outstanding is due to a combination of higher charge-offs, tighter credit, and less consumer willingness to take on debt, but probably not to widespread increases in discretionary paydowns of existing debt.

Although households account for the vast majority of credit card loans and credit card spending in our economy, the market for small business credit cards has grown considerably over the past 10 to 15 years. After checking accounts, credit cards are the second-most-common financial product used by small businesses. Small business cards are structured to cater to business needs with features, pricing, and underwriting unique to their typical usage. Issuers provide several services specifically for small businesses, such as employee cards with customizable spending limits and detailed spending statements each month or quarter. Also, small business cards often have higher credit limits than personal cards to facilitate the higher spending needs of small businesses.

Small businesses are noticeably less likely than households to carry a balance on their cards. As of the end of 2009, 83 percent of small businesses used credit cards. Of those using credit cards, 64 percent used small business cards and 41 percent used personal cards. Despite the widespread use of credit cards, only a minority of small businesses–18 percent–reported borrowing on credit cards. In comparison, nearly one-half of households reported carrying a balance on their credit cards.³ Thus, although most small businesses appear to use credit cards for transactions purposes, and perhaps as a source of short-term credit, the data suggest that only a small fraction of them rely on credit cards as a source of longer-term credit. Yet even if firms do not carry a balance, reductions in the size of their credit card lines may strain their cash flow and force them to cut spending or require them to use more expensive forms of short-term credit, such as trade finance.

Investor Repurchase Requests
The cost associated with foreclosure documentation problems, including robo-signing, are not the only potential liabilities facing financial institutions in the wake of the mortgage and housing crisis. As losses in MBS have been escalating, investors in MBS and purchasers of unsecuritized whole loans are more frequently exploring, and in some cases asserting, contractual and securities law claims against the parties that originated the loans, sold the loans, underwrote securities offerings, or had other roles in the process. The essence of these claims is that mortgages in the securitization pools, or sold as unsecuritized whole loans, did not conform to representations and warranties made about their quality–specifically that the loan applications contained misrepresentations or the underwriting was not in conformance with stated standards.

The potential liability associated with contract claims in securitizations is usually called put back risk because many of the relevant agreements permit the buyer of the mortgages to put them back to the seller at par. Buyers can demand that the seller or another party that makes representations repurchase the mortgages if defects are found in the underlying loan documentation or in the underwriting that conflict with the sale agreements. Although the representations and warranties in the various agreements vary considerably, they frequently require that the defect materially and adversely affect the value of the loan before put back rights can be exercised. At the time of the put back, the mortgage loan may have become seriously delinquent or entered into default. Because underperforming mortgages are typically valued substantially less than par, the put back transfers any potential loss from the buyer back to the original seller or mortgage securitizer.

Given the poor performance of the mortgage assets, investors, including the Government Sponsored Enterprises (GSEs), have sought to pursue put back claims through various legal avenues, including requesting that mortgage servicers provide underlying mortgage files and the requisite documents. A GSE will generally buy a loan out of an MBS pool when the loan becomes 120 days delinquent. The GSE will then conduct a review of the delinquent loan file, and if it finds that the loan did not comply with its underwriting standards, it will request that the loan be repurchased by the originator/seller or that the GSE be made whole on any credit losses incurred.

During the third quarter of 2010, Fannie Mae collected $1.6 billion in unpaid principal balance (UPB) from originators, and currently has $7.7 billion UPB in outstanding repurchase requests, $2.8 billion of which has been outstanding for more than 120 days. Freddie Mac has $5.6 billion UPB in outstanding repurchase requests, $1.8 billion of which has been outstanding for more than 120 days. As of the third quarter of 2010, the four largest banks held $9.7 billion in repurchase reserves, most of which is intended for GSE put backs.

There are also pending claims by some investors alleging that underwriters and sponsors of securitizations failed to comply with the federal securities laws covering the offering documents and registration statements. These suits specifically reference descriptions of the risks to investors, the quality of assets in the securitization, the order in which investors would be paid, or other factors. Most of these lawsuits are in the early stages, and it is difficult to ascertain the probability that investors will be able to shift a substantial portion of the losses on defaulted mortgages back to the parties that sold the loans or underwrote the offerings.

While the full extent of put back exposure is for this reason hard to specify with precision, the risk has been known for some time and has been an ongoing focus of supervisory oversight at some institutions. However, in light of recent increased investor activity, the Federal Reserve has been conducting a detailed evaluation of put back risk to financial institutions. We are asking institutions that originated large numbers of mortgages or sponsored significant MBS to assess and provide for these risks as part of their overall capital planning process.

Supervisory Responses
The revelation of documentation flaws in foreclosure processes raise two kinds of questions for supervisors: First, what actions are appropriate and sufficient to respond to problems identified at specific regulated banking organizations? Second, what does the failure of supervisory examinations to uncover these flaws counsel for future supervisory practice?

With respect to the question of actions aimed at specific institutions, the Federal Reserve and the other federal banking agencies have significant supervisory and enforcement tools that can be used to address certain types of deficiencies in the foreclosure and mortgage transfer process. For example, numerous enforcement tools are available to address safety and soundness issues such as inadequate controls and processes, weaknesses in risk-management and quality control, and certain types of compliance weaknesses in foreclosure operations. These tools include supervisory enforcement actions that require an institution to correct deficient operations in a prescribed period of time and Civil Money Penalties (CMPs) for egregious actions. The agencies may also lower examination ratings, which can result in limiting the permissible activities and affiliations of financial firms and trigger other supervisory reviews and limitations, and restrict the ability of institutions to expand. The agencies also have the authority to assess CMPs on individuals who are responsible for violations, to issue cease and desist orders on responsible individuals, or, if the statutory criteria are met, to remove them from banking. In addition, we may make referrals to law enforcement agencies, or require institutions to file Suspicious Activity Reports, as appropriate.

Although the examinations are not yet fully completed, based on what we have already learned, the Federal Reserve expects to use many or all of these tools through the course of our review of foreclosure and other mortgage matters. In particular, the Federal Reserve has already emphasized to the industry and to institutions we supervise the importance of addressing identified weaknesses in risk-management, quality control, audit, and compliance practices. The problems that are evident to date raise significant reputation and legal risk for the major mortgage servicers. These weaknesses require immediate remedial action. They will also affect the rating assigned by Federal Reserve supervisors to management of bank holding companies, even where the servicing activity was in a banking subsidiary of a holding company. In addition, the federal banking agencies expect that employees are adequately trained and have sufficient resources to appropriately review the facts and circumstances of files when preparing documents, and that legal processes are fully and properly followed. Banking organizations also must ensure quality control for third-party service providers, including legal services.

With respect to future supervisory practice more generally, two points for increased emphasis are already apparent. First, this episode has underscored the importance of our using the new authority given the Federal Reserve in the Dodd-Frank Wall Street Reform and Consumer Protection Act to send our examiners into non-bank affiliates of large bank holding companies, including those in large institutions that have become bank holding companies only in the last couple of years.

Second, our experience suggests that the utility of examining and validating internal control processes within firms may extend beyond improvements to the specific processes subject to the exam. We have found that problems in foreclosure practices do not seem as pervasive in institutions in which we had previously examined other internal control processes, found shortcomings, and insisted on corrective action. While we would not draw strong conclusions from such a limited experience, it seems possible that a firm may improve its general approach to control processes once it has been required to remedy problems in discrete areas. If this relationship is borne out, it could be a significant advance in supervisory practice, insofar as resource constraints will always limit the number of supervisory examinations.

Possible Need for Structural Solutions
Beyond remedial or punitive measures directed at specific firms and future-oriented changes in supervisory practice, structural solutions may be needed to address the range of problems associated with mortgage servicing. Similarly, the foreclosure documentation problems are another reminder of the degree to which foreclosure has been preferred to mortgage modification, notwithstanding various efforts to change this imbalance. Here again, a more structural solution may be needed

The explosive growth of securitization as a vehicle for financing mortgages was accompanied by the emergence of a sizeable mortgage servicing industry–that is, a group of firms servicing mortgages that they did not own or, in many cases, that they had not originated. While there have surely been economies associated with this industry, there have also been chronic problems. It has been increasingly apparent that the inadequacy of servicer resources to deal with mortgage modifications–an area that was a point of supervisory emphasis–was actually a reflection of a larger inability to deal with the challenges entailed in servicing mortgages in many jurisdictions and dealing with a complicated investor base. For example, foreclosure procedures are specifically the province of real property law governed by the states, and can vary not only by state, but also within states and sometimes even within counties. With or without regulatory changes, it is quite probable that servicer fees to securitization trusts will increase to reflect the costs associated with the complexities of the contemporary mortgage model.

The impetus for change in the mortgage servicing industry is likely only to increase as the advantages of servicing rights for regulatory capital purposes become limited after the new Basel III requirements are implemented.¹ It is possible that servicing issues can be satisfactorily addressed through the actions of the various primary regulators. However, in light of the range of problems already encountered, and the prospect of further changes in the industry–including the possible migration of more servicing activity to non-banking organizations–it seems reasonable at least to consider whether a national set of standards for mortgage servicers may be warranted.

The case for concerted, coordinated action is much clearer with respect to the slow-moving pace of mortgage modifications. Regardless of the findings that emerge from the examinations underway, and remedial actions required to correct past mistakes, this episode has again drawn attention to what can only be described as a perverse set of incentives for homeowners with underwater mortgages. Homeowners who try to obtain a modification of the terms of their mortgages are all too frequently subject to delay and disappointment, while those who simply stop paying their mortgages have found that they can often stay in their homes rent free for a time before the foreclosure process moves ahead. Moreover, many homeowners believe, reportedly on the basis of communications from servicers, that the only way they can qualify for modifications is by stopping their mortgage payments and thus becoming delinquent.

Quite apart from the impact upon families who lose their homes, the dominance of foreclosures over modifications raises macroeconomic concerns. The number of foreclosures initiated on residential properties has soared from about 1 million in 2006, the year that house prices peaked, to 2.8 million last year. Over the first three quarters of this year, we have seen a further 2 million foreclosure filings, and an additional 2.3 million homes were in foreclosure at the end of September. All told, we expect about 2.5 million foreclosure filings this year and next year and about 2.4 million more in 2012. While our outlook is for filings to decline in coming years, they will remain high by historical standards. Currently, more than 4.5 million mortgage loans are 90 days or more past due or in foreclosure. These numbers compare to just 520,000 permanent loan modifications executed under the Treasury Department’s Home Affordable Modification Program (HAMP) and an additional 1.6 million proprietary loan modifications by servicers participating in the HOPE NOW Alliance program.²

The Federal Reserve believes that in most cases the best way to assist struggling borrowers is a mortgage modification allowing them to retain their home with an affordable mortgage payment. In a housing market where values have declined so much, following a period in which all actors relied upon rising house prices to sustain mortgage practices, foreclosures simply do not make sense as a preferred response. Foreclosures are costly to all parties and more broadly to our economy. Lenders and investors incur financial losses arising from the litigation expenses associated with the foreclosure process and the loss on the defaulted mortgage when the foreclosed property sells at a liquidation price that is substantially less than the loan balance. Local governments must contend with lower property tax revenue and the ramifications of neglected properties that may threaten public safety. Additionally, neighbors and neighborhoods suffer potential spillover effects from foreclosure sales because foreclosures may reduce the attractiveness of the neighborhood or may signal to potential buyers a forthcoming decline in neighborhood quality. In the end, an overhang of homes awaiting foreclosure is unhealthy for the housing market and can delay a recovery in housing markets and the broader economy.

Several possible explanations have been suggested for the prominence of foreclosures: the lack of servicer capacity to execute modifications, purported financial incentives for servicers to foreclose rather than modify, what until recently appeared to be easier execution of foreclosures relative to modifications, limits on the authority of securitization trustees, and conflicts between primary and secondary lien holders. Whatever the merits and relative weights of these various explanations, the social costs of this situation are huge. It just cannot be the case that foreclosure is preferable to modification for a significant proportion of mortgages where the deadweight costs of foreclosure, including a distressed sale discount, are so high. While some banks and other industry participants have stepped forward to increase the rate of modifications relative to foreclosures, many have not done enough. We need renewed attention in many quarters of government and the financial industry, and among investors in mortgage-backed securities, to the lagging incidence of modifications.

Mortgage Documentation and other Servicing Issues
Foreclosure is a legal process initiated to terminate a borrower’s interest in a property and is permitted only when the borrower has defaulted on the debt obligation for a specified period. The process allows the lender to sell the property and use the proceeds to satisfy the borrower’s unpaid debt to the extent it is secured by the property. Foreclosure requirements are generally established by state laws and each state has its own statutes, rules, and court decisions pertaining to foreclosures.

Some 23 states, known as judicial foreclosure states, require foreclosures to be reviewed and approved by a court. Nonjudicial foreclosure states have different processes for foreclosures that do not require the creditor to obtain court approval for a foreclosure, but instead impose varying waiting periods and documentation, filing, and notice requirements after a default occurs and before a foreclosure sale may take place. In nonjudicial foreclosure states, the homeowner typically has access to the court in a foreclosure matter only if the homeowner initiates a suit to stop the foreclosure process or seeks protection in a bankruptcy court.

Because mortgage servicers maintain the official accounting of all amounts paid and owed by borrowers, they serve as the critical link between borrowers and mortgage holders. In addition, servicers manage loan defaults, including the negotiation of loan modification and repayment plans with borrowers. Should the servicer decide to initiate foreclosure, it would often do so as the agent for third parties, such as securitization trusts. In this regard, servicers have responsibilities to investors holding residential MBS. Servicers also have responsibilities to borrowers to maintain accurate and complete records of payments received, amounts advanced, notifications made to borrowers, and changes of payment terms with respect to any mortgage modification discussions.

Foreclosure documentation typically requires an assertion that the agent bringing forth the action has the legal right to foreclose and that the loan is in default. The document filings contain details of the transactions and the amounts owed. These documents typically include attestations signed by individuals who have personal knowledge of the facts and who are properly authorized to make such assertions. In most jurisdictions, the documents must be signed by these individuals in the presence of a notary, following proper notarization procedures. Lenders and servicers are responsible for ensuring that the individuals who sign these documents are duly authorized and have appropriate knowledge of the facts and circumstances. In addition, lenders and servicers are responsible for ensuring the accuracy of records and the facts recited in the foreclosure documents.

State and local laws govern the recordation process for real estate transfers and mortgage filings and assignments. Given the multiple sales and assignments of mortgage loans that often occur, concerns have been raised regarding investors’ or servicers’ rights to initiate foreclosure actions. Although state-by-state practices vary considerably, generally the noteholder has the right to initiate foreclosure, once default has occurred, if an original note can be produced and the current holder’s ownership is verified. If there is no controversy concerning ownership of the note, but rather an inability to locate original documents, processes usually allow for foreclosure to proceed, albeit at some cost and delay. If there is some question of ownership, the investor or servicer may be required to produce evidence of ownership before a foreclosure can proceed.

Since matters regarding real estate titles and foreclosures are generally governed by state law, state attorneys general are undertaking a joint review of lenders and servicers focusing on the reported problems in foreclosures. In addition, numerous federal agencies have launched investigations, including the examinations in process by the federal financial regulators.

The Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, and the Federal Reserve are conducting an in-depth review of practices at the largest mortgage servicing operations. The interagency examinations and reviews focus on foreclosure practices generally, but with an emphasis on the internal control breakdowns that led to inaccurate affidavits and other questionable legal documents being used in the foreclosure process. The agencies are reviewing firms’ policies, procedures, and internal controls, including sampling loan files. We have also solicited the views of consumer organizations to help detect problems at specific servicers. The agencies expect the initial on-site portion of our work to be completed by the end of the year. The agencies plan to publish a summary overview in early 2011 that will describe the range of industry practices found in the examinations and identify weaknesses requiring remediation.

The Federal Reserve has supervisory and regulatory authority for bank holding companies and their nonbank subsidiaries, as well as for approximately 800 state-chartered banks that are members of the Federal Reserve System (state member banks), and certain other financial institutions and activities. We work with other federal and state supervisory authorities to ensure the safety and soundness of the banking industry, foster the stability of the financial system, and provide for fair and equitable treatment of consumers in their financial transactions. The Federal Reserve is engaged in both regulation, which involves establishing the rules within which banking organizations must operate, and supervision, which involves reviewing the efforts of banking organizations to abide by those rules and remain, overall, in safe and sound condition.

The Federal Reserve serves as the primary federal regulator for two of the 10 largest servicers affiliated with banking organizations, one a holding company affiliate and the other a state member bank. The Federal Reserve is participating with the other federal banking agencies in examining the foreclosure policies and practices of the other large institutions. For additional information on foreclosure processes, we have sent a self-assessment questionnaire to other Federal Reserve-regulated institutions that engage in mortgage servicing but are not part of the interagency examination effort.

While quite preliminary, the banking agencies’ findings from the supervisory review suggest significant weaknesses in risk-management, quality control, audit, and compliance practices as underlying factors contributing to the problems associated with mortgage servicing and foreclosure documentation. We have also found shortcomings in staff training, coordination among loan modification and foreclosure staff, and management and oversight of third-party service providers, including legal services. It is for this reason that we expanded the review to include an examination of pre-foreclosure loans, or those past due but not yet in the foreclosure process, and certain third-party service providers. As examiners identify weaknesses, they will require firms to take remedial action and, when necessary, require servicers to address resource shortfalls, training and coordination problems, and control failures.

It is important to recognize that the extent of these problems is not the same across all firms. Nonetheless, the problems are sufficiently widespread that they suggest structural problems in the mortgage servicing industry. The servicing industry overall has not been up to the challenge of handling the large volumes of distressed mortgages. The banking agencies have been focused for some time on the problems related to modifying mortgage loans and the large number of consumer complaints by homeowners seeking loan modifications. It has now become evident that significant parts of the servicing industry also failed to handle foreclosures properly.

While we are still in the process of determining the extent of these problems and the required supervisory response, it is clear that the industry will need to make substantial investments to improve its functioning in these areas and supervisors must ensure that these improvements occur. Moreover, fixing the problems in the mortgage servicing industry may also require thinking about some fundamental structural changes to the current mortgage system. I will discuss the issue of structural solutions to these issues in more detail later in my testimony.

Speech at the Committee for Economic Development 2010 International Counterparts Conference, New York, New York

Speech at the Sixth European Central Bank Central Banking Conference, Frankfurt, Germany

Speech at the Sixth European Central Bank Central Banking Conference, Frankfurt, Germany

Testimony before the Subcommittee on Housing and Community Opportunity, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Speech at the National Consumer Law Center’s Consumer Rights Litigation Conference, Boston, Massachusetts

Speech at the The George Washington University Center for Law, Economics, and Finance Conference on the Dodd-Frank Act, Washington, D.C.

Speech at the Securities Industry and Financial Markets Association, New York, New York

Speech at the Federal Reserve System and Federal Deposit Insurance Corporation Conference on Mortgage Foreclosures and the Future of Housing, Arlington, Virginia

Speech at the Money Marketeers of New York University, New York, New York

Speech at the Grand Opening of the Junior Achievement Finance Park, Fairfax, Virginia

Speech at the Revisiting Monetary Policy in a Low-Inflation Environment Conference, Federal Reserve Bank of Boston, Boston, Massachusetts

Speech at the Annual Meeting of the National Association for Business Economics, Denver, Colorado

Speech at the Annual Meeting of the Rhode Island Public Expenditure Council, Providence, Rhode Island

Speech at the Federal Reserve System Town Hall Meeting with Educators, Washington, D.C.

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Speech at the Conference Co-sponsored by the Center for Economic Policy Studies and the Bendheim Center for Finance, Princeton University, Princeton, New Jersey

Testimony before the House Committee on Financial Services, Washington, D.C.

Speech at the Brookings Panel on Economic Activity, Washington, D.C.

Testimony before the Financial Crisis Inquiry Commission, Washington, D.C.

Speech at the Federal Reserve REO and Vacant Properties Summit, Washington, D.C.

Testimony before the Financial Crisis Inquiry Commission, Washington, D.C.

Speech at the Federal Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming

Speech at the Annual Meeting of the Southern Legislative Conference of the Council of State Governments, Charleston, South Carolina

Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.. Chairman Bernanke presented identical remarks before the Committee on Financial Services, U.S. House of Representatives, on July 22, 2010

Testimony before the Subcommittee on Security and International Trade and Finance, Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C.

Testimony before the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services, U.S. House of Representatives, Washington, D.C.

Speech at the Public Hearing on Potential Revisions to the Home Mortgage Disclosure Act, Atlanta, Georgia

Speech at the Federal Reserve Meeting Series: "Addressing the Financing Needs of Small Businesses", Washington, D.C.

Speech at the Federal Reserve Meeting Series: "Addressing the Financing Needs of Small Businesses", Washington, D.C.