Federal Reserve Chairman Ben Bernanke has said that the financial system can survive the fallout from the subprime-mortgage market ‘without serious problems.’ The Federal Reserve does not anticipate broader economic consequences from the growing number of mortgage defaults and home foreclosures. Speaking at the Federal Reserve Bank of Chicago in his most exhaustive remarks so far on the mortgage market’s recent troubles, Bernanke said regulation must ‘walk a fine line’ between protecting consumers and making sure that people who deserve credit can get it.
The Fed chief said in response to a question following his speech. ‘We have spent a bit of time evaluating the financial implications of the subprime issues, tried to assess the magnitude of losses, and tried to determine how concentrated they are’. He further added, ‘There is a sense that, although there is always a possibility for some kind of disruption but the financial system will absorb the losses from the subprime mortgage problems without serious problems.’
The Fed chief’s comments suggest that the central bank has raised its guard against a second credit bubble flourishing in the form of leveraged buyouts at a time when the US economy is dealing with the mortgage bust. Lawmakers and consumer advocates have blamed the Fed and other regulators for lenient enforcement while lenders wrote a record $2.8 trillion in mortgages from 2004 to 2006. Bernanke’s recent remarks follow comments from New York Fed President Timothy Geithner, the central bank’s chief liaison to Wall Street that officials are ‘looking carefully’ at the loans that finance leveraged buyouts. Banks are helping fund a record speed of acquisitions this year, with the value of announced LBOs soaring 40 percent to $188 billion in the first quarter.
As a matter of fact, leveraged buyout companies are private investment firms that use debt to cover around two-thirds of the price of their takeovers. The bonds and loans would certainly be at risk if the acquired company runs into financial trouble and cannot meet its obligations and target.
At the same time, lawmakers lashed out on the Fed for not publicly reprimanding any bank for failing to follow up on guidance on mortgage lending practices. Subprime loans accounted for an increasing share of the market as the value of mortgages written rose 40 percent in the three years through 2006. Bernanke has informed that subprime mortgages made up more than half of the foreclosures in the fourth quarter of 2006. He further hinted that the central bank is reviewing its authority to disallow lending specific practices. Facing criticism from several quarters including members of Congress over relaxed regulation, Bernanke in his prepared remarks promised that the Fed would do everything possible to crack down on abuses that have put millions of homeowners in jeopardy of defaulting on their mortgages.
