Elizabeth Duke

Just as public focus, experimentation, and policy debate have informed best practices with regard to loan modifications, we must also begin the work of developing responsible foreclosure and real estate inventory management protocols. Minimizing the amount of time that properties remain vacant and maximizing the price at which they are sold will serve the interests of both lenders and the communities. At this moment, lenders and communities alike are woefully under-resourced and unprepared for the volume of real estate that will need to be processed.

One widely held misperception is that CRA is only about mortgage lending to low- and moderate-income borrowers in lower-income neighborhoods.  As a former community banker, I know that CRA's impact is just as important in meeting the needs of small farms and businesses and, as such, it serves as a valuable catalyst for job creation in both urban and rural areas across the country.  This point is particularly noteworthy at a time when mounting job losses are adding to the woes of consumers and exacerbating the problems in housing and mortgage lending.

[I]t must be recognized that there are many types of banks in the United States with different specializations, geographic concentrations, and comparative advantages. Consequently, the extraordinary stress in the financial system, the downturn in the U.S. and global economies, and the associated reductions in asset values have affected each bank differently.

I hope we have learned that misaligned incentives that result in harm to consumers have implications for the economy overall. If we recognize this, then we must also recognize that consumer protections cannot be viewed as an ancillary component of a scheme to regulate for safety and soundness.

[W]ith the exception of housing, lending over the current downturn does not appear particularly weak or subdued relative to other downturns. Indeed, for all categories of lending other than home mortgage lending...there are at least two other downturns for which the paths of lending after the business cycle peak lie below that following 2007:Q4

[T]he objective of liquidity programs is to facilitate the intermediation of credit to households and businesses. The immediate goal of such facilities, however, is the reduction of stresses in the interbank funding market. The significant narrowing since the start of this year in important measures of stress in this market--specifically, Libor-OIS spreads, shown in the left panel of figure 2--together with diminished usage of these facilities--shown to the right--suggest that some easing in this market has occurred in line with the implementation and expansion of these initiatives.

The program {asset purchases} appears to be having its intended effect. Yields on mortgages relative to Treasury yields have come down since November 2008...[T]he 30-year fixed mortgage rate relative to the 5-year constant maturity Treasury rate benchmark has declined about 1-1/4 percentage points since the first MBS purchase program was announced. Indeed, today mortgage spreads are a lot closer to their mean for 2000-2007 than they were in November. That said, mortgage rates have recently risen with the increase in Treasury rates.

Economic conditions are stabilizing or, where they are still deteriorating, appear to be doing so more slowly. But economic activity is still at a low level.

In the past, systemic risk had been thought of as involving a single large institution. In the recent cases, we invoked the systemic risk exception with respect to the system as a whole, thereby allowing assistance to flow to institutions of all sizes.

For its part, the Federal Reserve has also taken steps to assist smaller institutions. For example, all banks can borrow funds under the Federal Reserve Term Auction Facility, which operates much the same as the discount window, but offers longer terms. And Regulation D was recently modified to allow community banks to earn interest on excess reserves held in bankers' banks on a pass-through basis.

[T]he Federal Reserve Board believes there is a compelling case for leaving consumer protection rule writing functions within the Federal Reserve and supervision with the agencies responsible for prudential supervision. While arguments for consolidating functions can themselves be compelling, it is important to also consider the substantial opportunities presented by existing arrangements.
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[T]he Federal Reserve has the resources, the structure, and the experience to execute an ongoing comprehensive program for effective consumer protection in financial services...[W]e believe that replicating in another agency the deep expertise and full array of functions embedded within the Federal Reserve and used to support our consumer protection program would be enormously challenging. We also view consumer protection as complementary to, rather than in conflict with, other responsibilities at the Federal Reserve, such as prudential supervision and fostering financial stability.

If the business model is predicated on the trading of financial instruments for the realization of value, or other strategies that essentially focus on short-term price movements, then fair value has relevance. In the trading business model, reporting fair value focuses risk management on short-term price movements and in most cases incentivizes management to define the organization's risk appetite and to mitigate risk through hedging or other means...

In contrast, if the business model is predicated on the realization of value through the return of principal and yield over the life of the financial instrument, then fair value is less relevant. Consider, for example, a bank that finances the operations of a commercial enterprise. The realization of value will come from the repayment of cash flows. Risk management is based on an assessment of the borrower's creditworthiness and the entity's ability to fund the loan to maturity. In this case, the accounting should incentivize the entity to maintain sufficient funding to hold the instrument to maturity and to hold a sufficient amount of capital to cover potential credit losses through the credit cycle, preferably in a designated reserve. Indeed, the use of fair value could create disincentives for lending to smaller businesses whose credit characteristics are not easily evaluated by the marketplace.

Work is underway to develop an approach that would allow banks to retain more capital in good economic times and to allow this excess or buffer to be reduced as the economic cycle worsens. The goal is to have a level of capital that is sufficient to support lending, while maintaining safety and soundness. The challenge is to develop an appropriate target for this excess amount and to identify the right economic trigger for determining when this excess should be reduced. This is a delicate balance.

The Supervisory Capital Assessment Program (popularly known as the stress test) provides a window into the likely future of bank supervision as well as the accounting issues encountered by regulators in evaluating capital adequacy. The stress test was a simultaneous, horizontal review of the 19 largest financial institutions in the United States. The review was led by the Federal Reserve, but conducted jointly with other federal banking regulators. In essence, we focused on three key pieces of information--pre-provision net revenue, potential losses, and final equity capital.

Communities with weak underlying economies are characterized by a long trend of population loss, gradual impoverishment, and strained municipal resources. For cities like Cleveland, Detroit, and Indianapolis the increase in foreclosures over the last few years has exacerbated a pre-existing vacancy problem. The increased rates of foreclosures and the related economic downturn have hastened a cycle of decreasing property values.

The combination of reduced cash flows and higher rates of return required by investors leads to lower valuations, and many existing buildings are selling at a loss. As a result, credit conditions in this market are particularly strained. Commercial mortgage delinquency rates have soared. According to our October survey of senior loan officers, banks continued to tighten standards on CRE loans and, presumably in light of the poor economic outlook for the sector, appear to have been reluctant to refinance maturing construction and land development loans. In addition, the CMBS market has only just recently seen its first activity in a year and a half.

In this environment, a turnaround in CRE is likely to lag the improvement in overall economic activity.

In theory, it is the higher rate that keeps banks from using the discount window as a regular source of funds. In practice, bankers are quite suspicious that borrowing from the Federal Reserve will bring additional regulatory scrutiny. In my banking days, I always described it as being like borrowing from my father. I was always sure that at some point I would have to answer uncomfortable questions.

The hike in the discount rate to 0.75 percent from 0.5 percent, effective Friday, and the earlier ending of some extraordinary credit programs represent "further normalization of the Federal Reserve's lending facilities" and nothing more, said Duke.

"They do not signal any change in the outlook for monetary policy and are not expected to lead to tighter financial conditions for households and businesses," she said in an address at the Economics Club of Hampton Roads, in Norfolk, Virginia, echoing a statement by the Fed in announcing the rate hike.

As reported by Reuters

[W]e recognize that the ongoing financial and economic stress has resulted in a decrease in credit availability, including loans to small businesses, and has prompted institutions to review their lending practices. Although current loss rates would indicate that a measure of tightening was appropriate and necessary, some institutions may have become overly cautious in their lending practices. Thus, while prudence must remain the watchword for both banks and their supervisors, we do not want our examiners to take an overly mechanistic approach to evaluating small business lending.

I do believe that an independent Fed is good our economy and critical for the implementation of monetary policy.

[T]he Federal Reserve has placed particular emphasis on ensuring that its supervision and examination policies do not inadvertently impede sound lending to businesses, both large and small, and we will continue to do so. Actions taken to stabilize the largest banks during the crisis have received a lot of attention. However, I think it is equally important to note the degree to which banks of all sizes were offered access to the same loan, guarantee, and capital facilities. We should never forget that the objective was to save the system as a whole, not just a handful of large institutions.

We have not yet seen any substantial improvement in hiring rates. Aggressive moves by businesses to reduce costs by cutting jobs and work hours have resulted in solid gains in aggregate productivity. This bodes well for increased employment in the coming year, but I anticipate that employers will add jobs cautiously in order to preserve these cost savings and efficiency gains for as long as possible.

Consumers will reengage slowly as confidence, income, and balance sheets strengthen.

Responding to audience questions afterward, Duke said her opinion is that the Fed shouldn’t begin selling its more than $1 trillion in mortgage-backed securities until after it raises interest rates. The central bank should communicate sales “well in advance to the markets so that markets aren’t surprised,” Duke said.

We are paying attention and we are in the right place [regarding monetary policy.]

I do not believe it is appropriate or even possible for regulators to urge banks to make loans that are outside their risk tolerance or that would be unsafe or unsound. But we can and should be sure that supervisory policies do not impede the flow of credit to all eligible borrowers. That's why the Federal Reserve and other regulatory agencies have worked so hard during the past few years to ensure that while banks appropriately recognize loan problems they also can continue to make loans that are safe and sound.

Clearly, the recent mortgage crisis has highlighted the potential ramifications of a mortgage market that is not functioning well. Data do not create the market, but they do help us understand what is happening in the market... With the benefit of hindsight, we can now answer the question: Do policymakers have adequate and reliable data sufficient to assess market conditions and craft policy responses?

Today's financial landscape is vastly different from the one in which the Community Reinvestment Act was enacted in 1977... In the wave of the foreclosure crisis, there are new challenges.

The formation and growth of small businesses depend critically on access to credit and other financial services... Any changes we make to the regulation should retain the flexibility that has been integral to the CRA’s success.

Including rental options among the mix of stabilization strategies makes particular sense at a time of high unemployment. Even in the best of times, homeownership limits mobility in the labor market.

Clearly, the recent mortgage crisis has highlighted the potential ramifications of a mortgage market that is not functioning well. [Home Mortgage Disclosure Act] data do not create the market or solve all market problems, but they do help us understand what is happening in the market. The time is certainly ripe for reviewing and revising the data elements, standards, and reporting formats.

Using new tools to manage policy as we have in the last two years does create particular challenges in communicating our actions, intentions, and reasoning to the public. The statement has been an essential element in addressing these challenges. For example, the announcement of a target for the federal funds rate combined with a phrase such as "extended period" gives the market a sense of current policy and the policy expectations for the future. Over time, market participants have learned how to translate that sort of statement into expectations for market and economic conditions. When we began large-scale purchases of mortgage-backed securities and agency debt, however, that decision was much more difficult to interpret. So we communicated that we expected to purchase x amount of securities over y amount of time. In subsequent statements, we reiterated that intention, added to some totals, subtracted from others, added purchases of Treasury securities, and ultimately stated our intentions to stop purchasing the securities.

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.

[I]n a 2006 speech about the historic use of monetary aggregates in setting Federal Reserve policy, Chairman Bernanke pointed out that, "in practice, the difficulty has been that, in the United States, deregulation, financial innovation, and other factors have led to recurrent instability in the relationships between various monetary aggregates and other nominal variables." Still, my colleagues and I will be monitoring a wide range of financial and economic developments very closely -- including the growth of the money supply, inflation, and many other financial and nonfinancial variables -- and, based on a full assessment of those developments, the FOMC will withdraw monetary accommodation at the appropriate time. My view is that the elevated reserve balances would be inflationary only if they prevented the FOMC from effectively removing monetary accommodation by raising interest rates when the time comes to remove such accommodation, and I am convinced that that will not be the case.

The ability to make monetary policy decisions that are free of short-term political influence is critical for central banks. This is especially true because the effective conduct of monetary policy requires a long-term perspective. A central bank that is subject to political pressure might opt for policies that favor rapid expansion in the near term at the expense of higher inflation in the future. Such actions would surely result in the loss of the confidence and credibility that are needed to achieve the objectives of monetary policy.

While credit availability seemed to improve for large companies throughout the past year, small businesses still complained of difficulty in gaining access to credit. Recent anecdotes lead me to believe that conditions are improving for small businesses.

Foreclosed, vacant, and abandoned properties threaten neighborhoods nationwide, and community leaders are working to stabilize those neighborhoods. While the problem touches every community, it doesn't look the same in each because it's shaped by the circumstances that prevailed in those neighborhoods before the crisis hit. Neighborhood stabilization efforts are critical, now more than ever, as not all communities will be stabilized without intervention.

At this point, I am pleased to tell you that recent anecdotal evidence leads me to believe that conditions are improving for small businesses.

Comprehensive, effective regulation of consumer products is the first step in ensuring positive outcomes for consumers. But consumers must also be equipped with the necessary quantitative and decisionmaking tools, and supported with the right information at the right time in order to make the best possible choices.

I expect continued moderate recovery in 2012. My forecast is for the unemployment rate to gradually (and perhaps fitfully) move lower and for inflation to settle over coming quarters at or below levels consistent with the Federal Reserve's dual mandate. In this environment, I believe that the current stance of monetary policy is appropriate.

I do not believe that establishing an inflation target is inconsistent with a commitment to both parts of the dual mandate. On the contrary, it can help with thinking about and achieving both of our mandated objectives. For example, if having an explicit numerical target for inflation helps anchor inflation expectations over the longer run, then monetary policy will have greater flexibility to pursue the goal of maximum employment in the shorter term.

[A]s we and other agencies craft regulations to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) and adjust supervisory practices to meet these priorities, I think we must avoid a one-size-fits-all approach to supervision.

No one can argue with the need for stronger regulation to prevent the lending abuses that led to the current foreclosure crisis. However, I think it would also be unfortunate if the laws and regulations put in place to require other lenders to adopt the same responsible practices long used by community banks are so complicated and expensive that they have the unintended effect of forcing some community banks to leave the market.

In particular, the failure of the housing market to respond to lower interest rates as vigorously as it has in the past indicates that factors other than financial conditions may be restraining improvement in mortgage credit and housing market conditions and thus impeding the economic recovery.

The foreclosure crisis that resulted from unsustainable subprime lending has persisted largely because of high unemployment rates. Thus, in order to be successful, any effort to stabilize and revitalize lower-income neighborhoods will need to consider housing through the lens of access to jobs and educational opportunities.

Nearly three and a half years after the GSEs entered conservatorship, policymakers have reached no consensus about the future structure of the GSEs and the role the government should play in the mortgage market. Private capital might be reluctant to enter the market until the future parameters of government support are resolved.

Without commenting on the specifics of any of these individual regulatory rules under consideration, I think it is important to note that potentially each of them--servicing requirements, capital requirements, and underwriting requirements--will affect the costs and liabilities associated with mortgage lending and thus the attractiveness of the mortgage lending business. The Federal Reserve is aware of this situation and will apply its best judgment to weigh the cost and availability of credit against consumer protection, investor clarity, and financial stability as it writes rules that are consistent with the statutory provisions that require those rules. But regardless of what the final contours of the rules are, I think the mortgage market will benefit from having them decided so that business models can be set and investments calibrated.

Central banks typically work individually to achieve objectives for their domestic economies. In the case of the Federal Reserve, monetary policy is conducted to achieve our statutory objectives of maximum employment and price stability. And, of course, fostering a stable financial system is key to attaining these goals. But the experience of the past few years has illustrated--first with the global financial crisis and more recently with the strains in Europe--that cooperation and coordination among central banks around the world may be necessary at critical junctures to achieve these domestic objectives.

Indeed, the global financial crisis has underscored the importance of the financial stability objective of central banks. Given the global nature of financial markets and large financial institutions, coordination and cooperation among central banks and bank supervisors and regulators more generally is crucial in achieving this goal.

In this age of global financial integration, the Federal Reserve and other central banks often must cooperate to achieve their individual mandates. This need for coordination has been especially true during the recent crisis, when the actions of central banks working together proved very helpful in easing financial strains and boosting confidence. Indeed, closer ties and more-open lines of communication across central banks are some positive outcomes of these difficult times. This spirit of cooperation should continue as our respective central banks work to pursue monetary policies appropriate for our own economies while supporting stable financial systems around the world.

Research conducted by the Federal Reserve Bank of Cleveland has shown that a home that is simply foreclosed, but not vacant, lowers neighboring property values by up to 3.9 percent. However, if a home is foreclosed, tax delinquent, and vacant, it can lower neighboring property values by nearly two and a half times that amount. Moreover, properties that have been vacant for a substantial period of time can impose even larger costs on the community, and all too often, the private market is not likely to solve the problem on its own. In such cases, government authorities and public resources may be required.

[I]t is entirely possible that it might be appropriate at some point to adjust the pace of MBS purchases in response to developments in primary or secondary mortgage markets. Within the context of the Committee's judgment about the appropriate overall level of monetary accommodation, such an adjustment could result in an increase or decrease in the pace of total asset purchases, or it could lead to a change in the composition of purchases.