Most forecasters do not expect to see a bottom in housing construction until early 2009. By then, homebuilders will have probably worked off the bulk of their excess inventories of unsold new homes. However, the inventory of existing homes on the market remains near record-high levels, and it seems likely that it will take longer to work off that inventory. Sales of new and previously sold single-family homes appear to have stabilized over the past few months. It seems unlikely that sales would have stabilized if buyers were still expecting steep price declines.

I would note one -- two things. First, as a minor point, that one of the things that this program being discussed could do would be to purchase second liens, which have proved to be a very significant barrier to the resolution of -- of foreclosures.

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Well, second liens are selling for a few cents on the dollar. I wouldn't expect them to be worth much more than that.  But I was only pointing out that -- I know this from Governor Duke, who's on the Hope for Homeowners board, that the problem with second liens is a big issue right now, because it prevents renegotiations of the first mortgage.  So I was just saying that a side effect, if we do buy them at market value, a few cents on the dollar, would be to help free up this -- this other issue.

From the Q&A session

...[R]estraint on credit supplies is likely to persist because intermediaries have some way to go to rebuild their balance sheets.  The process of adjustment to a safer, more resilient financial system is going to take a while.    

The housing market still has some way to go.  We see relatively few signs that house prices have bottomed out.

I would like to underscore the Federal Reserve's commitment to preserving and supporting minority depository institutions.  I look forward to continuing our constructive dialogue on finding the best and most practical ways to address the challenges that these banks confront.  I am confident that we will be successful in ensuring that these companies remain strong and continue to provide critical financial support to their communities. 

There are some very tentative signs of improvement in existing home sales, and my expectation is that housing will be less of a drag on growth as we move through 2009.

The Federal Reserve is also leveraging its strengths in data analysis and research, and many of the Reserve Banks are publishing new papers that can help us to understand the multi-faceted nature of the current mortgage crisis.

Most observers are very hesitant about calling a bottom in housing construction, sales or prices, a hesitancy that I share. And even if housing market activity does manage to bottom out later this year, it is likely that any recovery would be exceedingly slow.

Today we are also looking more broadly for ways to increase the availability and lower the cost of mortgage financing to accelerate the return of normal homebuying activity. We are working with FDIC, the Federal Reserve, the OCC and the OTS to explore the potential of covered bonds, which is one promising financing vehicle to do just that. Covered bonds provide funding to an issuer, generally a depository institution such as a commercial bank or thrift, through a secured debt instrument collateralized by a pool of residential mortgage loans that remain on the issuer's balance sheet. Interest is paid to investors from the issuer's cash flow. In the event of a default, covered bond investors' primary recourse is the pool of mortgage loans, and secondary recourse is an unsecured claim on the issuer. Covered bonds have been widely used in Europe to finance residential and commercial real estate, and municipal bonds. At the end of 2006 the European covered bond market was over 1.9 trillion Euros.

And, as Treasury seeks to encourage new sources of mortgage funding in the United States, improve underwriting standards and strengthen financial institutions' balance sheets, covered bonds have the potential to serve these purposes and reduce the costs for first-time home buyers, and for existing homeowners to refinance.

The balance-sheet pressures, and broader financial market dislocations, are likely to be with us for some time. My expectation is that market functioning will improve markedly by 2009. But things could get worse before they get better. For example, home prices could fall more than markets expect, leading to larger losses for financial institutions and further impairing their ability to make new loans. The credit crunch could then lead to further declines in house prices. The resulting decline in household wealth could then further reduce spending, leading to additional knock-on effects. So an adverse feedback loop could develop, with consequences for both financial markets and economic activity.

We continue to encourage lenders and mortgage servicers to work constructively with borrowers at risk of default and to consider prudent workout arrangements to avoid unnecessary foreclosures. As you know, the Federal Reserve believes that prudent workout arrangements that are consistent with safe and sound lending practices are generally in the long-term best interest of both the financial institution and the borrower.

Furthermore, we are working to finalize the proposed amendments to the rules under the Home Ownership and Equity Protection Act that we proposed in December...Our proposal includes key protections for higher-priced mortgage loans secured by a consumer's principal dwelling and addresses concerns about a lender's assessment of a borrower's ability to make the scheduled payments, including verification of the consumer's income and assets. The proposal also addresses concerns about prepayment penalties and the adverse impact on consumers of lenders failing to escrow for taxes and insurance. Protecting consumers also has benefits for lenders because it should reduce delinquencies and defaults that can occur when consumers do not understand or cannot afford certain types of loans.

 Most lenders have eliminated many riskier innovative mortgage products from their line-ups, which makes sense given the recent performance of such products, but which makes homeownership more costly than it was during the boom. Thus, most observers are very hesitant about calling a bottom in housing construction, sales or prices. And even if housing market activity does manage to bottom out later this year, it is likely that any recovery would be exceedingly slow.

What about today? Using the same rough method to approximate home equity for the same subset of homeowners, the data imply that about 10 percent of post-1987 purchasers were in a position of negative equity as of the fourth quarter of 2007. Assuming that the unemployment rate and benchmark interest rate (the 6-month London Interbank Offered Rate or LIBOR) stay at their fourth-quarter 2007 levels, the statistical default model of Gerardi, Shapiro and Willen predicts that less than 10 percent of these homeowners with negative equity will default.

Continued declines in house prices, higher unemployment, and possibly a greater willingness to default on home mortgages might raise this estimate of future defaults. Even so, many lenders will not be inclined to make concessions unless borrowers clearly lack the ability to pay.

Despite some promising proposals, these factors – the presence of piggyback loans, the desire of lenders to continue to get paid unless the borrower does not have the capacity to make payments, and the legal restrictions and tax-liability concerns surrounding securitization agreements – make any across-the-board modification of loan terms challenging. 

As long as loan modifications are taking place on a loan-by-loan basis (a time-consuming and labor-intensive process), to significantly increase the number of loan modifications and avoid significant numbers of foreclosures, many servicers will need to quickly expand the pool of staff capable of making these evaluations. 

To reiterate, falling housing prices continue to be a significant source of down-side risk to the economy.  Previous periods of real estate problems have taken significant time to be worked out, with foreclosures remaining elevated well after their peak.  The current foreclosure problem has been exacerbated by the difficulties related to many of the problem loans being held in securities.