FedÕ Krozner: Improved Underwriting, Risk Management Critical to Mortgage Market Recovery

Recovery in the mortgage markets will take some time to materialize, although it will materialize — eventually — Federal Reserve governor Randall Krozner said Thursday afternoon. Characterizing market recovery as “a gradual process that requires both market and regulatory discipline,” Krozner said that better information and transparency will be needed to restore investor confidence and bring liquidity back to a mortgage market that has been battered, and in some sectors, even left for dead. In remarks delivered at the Conference of State Bank Supervisors Annual Conference in Florida, Krozner focused on the dynamics of a mortgage recovery, and said that better underwriting and improved risk management practices would underpin any return to normalcy in the secondary market. “The process of recovery and repair in non-agency mortgage securitization markets would also be aided by more clarity and consistency in underwriting standards,” he said, noting that the Federal Reserve has proposed stricter underwriting rules for high-cost mortgages under the Home Ownership and Equity Protection Act (HOEPA). Final regulations on “high-cost lending” are expected to be issued in July. Krozner also suggested that risk management practices spanning liquidity risk and valuation practices would be critical going forward. “Part of the reason that the problems with subprime and alt-A mortgages led to much wider financial market turmoil was weaknesses in the risk-management practices at some large global financial firms that created and held complex credit products,” he said. That Krozner would focus on liquidity risk is telling, sources tell Housing Wire; in his speech, he alluded to “times of systemwide stress” when “liquidity shocks can become correlated.” While he didn’t use the word, Krozner’s remarks suggested that the Fed now believes that systemic credit problems can lead to a crisis of solvency for key financial institutions. Many financial market experts have argued recently that market problems have been of the solvency variety, rather than a vanilla liquidity crisis. “Because risk concentrations have the potential to manifest themselves during times of stress and at that time adversely affect capital positions,” Krozner said, “it is particularly important that firms assess how liquidity events could place pressure on capital levels.”