Bernanke: Go slow on subprime regulation

Fed chief cautions against wholesale action to solve the subprime lending crisis.

By Les Christie, staff writer

NEW YORK ( -- Facing criticism from some members of Congress over lax regulation of the nation's mortgage market, Federal Reserve Chairman Ben Bernanke came out swinging Thursday against too much government intrusion in the troubled subprime mortgage business.

In a speech before the Federal Reserve Bank of Chicago on Thursday, Bernanke outlined the background and run-up to the present crisis in subprime lending and gave his view of what adjustments government regulators needed to make to minimize the scope and severity of subprime mortgage problems.

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Although he stressed that regulators should take the lead in combating abusive lending practices, he clearly did not want to throw out the baby with the bathwater.

"We at the Federal Reserve will do all that we can to prevent fraud and abusive lending and to ensure that lenders employ sound underwriting practices and make effective disclosures to consumers," Bernanke said. "At the same time, we must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers.

"Any new rules that we issue should be sharply drawn," he added. "Insufficiently clear rules could create legal and regulatory uncertainty and have the unintended effect of substantially reducing legitimate subprime lending."

According to Bernanke, there's much that regulators can do: Work with lenders to make sure disclosures about loan terms and fees are understood by borrowers; prohibit abusive, unfair and predatory lending practices; offer guidance and supervisory oversight and take informal actions like encouraging sound practices and working with credit counseling organizations to better educate consumers.

But, according to Bernanke, the kinds of innovations in credit markets represented by exotic subprime loan products have had a positive effect, opening up home-buying opportunities for millions of Americans.

During the years when subprime products came into wider use, homeownership has expanded from about 65 percent of all Americans in 1995 to 69 percent today, he said.

The increase in homeownership also coincided with the expansion of secondary markets in which mortgage loans were packaged and sold to investors. The secondary market added welcome liquidity to mortgage markets; home buyers found it far easier to obtain financing.

An additional result, however, was that the secondary market provided incentives for lenders to make more loans - their revenue was tied to volume - and so to reduce underwriting standards.

The increase in risky loans contributed to a big jump in default and foreclosure filings this year.

"Markets can overshoot, but, ultimately, market forces also work to rein in excesses," Bernanke said. "For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit."

And while he advocated that regulators maintain their vigilance in fighting against fraud and abusive lending, that came with a caveat.

"We must be careful not to inadvertently suppress responsible lending or eliminate refinancing opportunities for subprime borrowers," he said. "Our success in balancing these objectives will have significant implications for the financial well-being, access to credit, and opportunities for home ownership of many of our fellow citizens."

Bernanke struck a positive note regarding the impact of subprime foreclosures on the overall economy, noting the impact would be limited. He added that financial institutions will be able to absorb the losses caused by defaulting borrowers. Top of page