U.S. Treasury Secretary Henry M. Paulson Jr. today told bank regulators that home prices will continue to fall, foreclosures will continue to rise and some borrowers should not be saved. He did note, however, that although subprime lending needs to be fixed -- it shouldn't be eliminated.
Paulson made his comments at the Federal Deposit Insurance Corporation's Forum on Mortgage Lending, according to a transcript of his prepared statement.
He explained that following several years of lax lending standards and rapid home price appreciation, the housing correction that began in 2006 was inevitable. Most forecasts call for a prolonged period of adjustment, with foreclosures continuing to rise and housing prices continuing to fall.
Excess inventory is combining with tighter credit -- which has reduced the number of prospective buyers -- to hurt the housing market.
Some positive signs include a 21 percent decrease in inventory of new single family homes from the 2006 peak and a flattening of existing home sales over the past several months. In addition, depreciation has helped bring starter home prices within reach of more buyers.
The secretary explained that home prices in California, Florida, Arizona and Nevada more than doubled between 2000 and 2006 while Indiana, Michigan and Ohio have seen greater economic challenges. These seven states, which account for one-third of outstanding mortgages, have seen foreclosures soar 300 percent during the past two years and are responsible for more than half of foreclosure starts during the first quarter of 2008.
Around 2.5 million foreclosures are expected to be initiated this year, compared to 1.5 million in 2007. During 2004, when the economy and housing market was strong, there were only 800,000 foreclosures started.
Paulson warned that policy makers should not attempt to prevent every foreclosure. He cited situations such as speculators who are walking away just because they have negative equity and borrowers who have suffered life events including job loss.
"Many of today's unusually high number of foreclosures are not preventable," he stated. "Due to the lax credit and underwriting standards of the past years, some people took out mortgages they can't possibly afford and they will lose their homes."
The official said the objective has been to prevent foreclosures where borrowers were willing to make payments and could afford a workout plan but could not make contact in time with overwhelmed servicers. The HOPE NOW alliance was created to address these issues by facilitating a process where delinquent borrowers, whose loans were owned by investors of residential mortgage-backed securities, were dealt with as if they were dealing with a bank that had originated and held the mortgage.
Paulson touted the achievements of HOPE NOW, noting the alliance has been especially productive at increasing communication with delinquent borrowers and assisting subprime adjustable-rate mortgage borrowers.
Second liens had become a problem for servicers attempting a loan workout, so HOPE NOW announced guidelines for automatic re-subordination of second liens.
The share of all new mortgages guaranteed by Fannie Mae and Freddie Mac has reached 70 percent, according to the secretary.
Paulson explained that some subprime loans should never have been made. He said that high loan-to-value, low- and no-documentation other lax credit loans have become a thing of the past. But he also said that subprime programs enabled many borrowers to purchase homes.
"We must not lose the benefits of the subprime market as we eliminate its flaws," he stated. "We know that subprime lending is vital to bring the dream and economic good of homeownership to millions of Americans. The subprime market will evolve as markets always do, to find better ways to evaluate and manage credit risk."
He pointed out the benefits of covered bonds, which remain on the issuer's balance sheet and give investors security in the event of default and enable an unsecured claim on the issuer.