WASHINGTON (MNI) – The following is the prepared testimony to be
delivered to the Senate Banking Committee later in the morning by
Federal Reserve Gov. Elizabeth Duke:

Chairman Johnson, Ranking Member Shelby, and members of the
Committee, thank you for inviting me to talk about the current situation
in housing markets.

The Federal Reserve has a keen interest in the state of housing and
has been actively engaged in analyzing issues in the housing and
mortgage markets. Issues related to the housing market and housing
finance are important factors in the Federal Reserves various roles in
formulating monetary policy, regulating banks, and protecting consumers
of financial services. 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. Federal Reserve staff have been
actively working to understand the reasons behind the impairment in
housing and mortgage markets and the tradeoffs involved in designing
policies that would remove obstacles to normal market functioning.

On January 4, 2012, the Federal Reserve released a staff paper
titled The U.S. Housing Market: Current Conditions and Policy
Considerations, which is attached at the end of my written statement.
The paper provides information on current conditions in the housing
market and analytic background on some housing market issues. Although
the paper does not include recommendations for any specific policy
actions, it does lay out a framework for discussion by outlining some
options and tradeoffs for policymakers to consider. My testimony today
will be drawn from this paper.

Six years after aggregate house prices first began to decline, and
more than two years after the start of the economic recovery, the
housing market remains a significant drag on the U.S. economy. In a
typical economic cycle, as the economy turns down households postpone
purchases of durable goods such as housing. Once the cycle bottoms out,
improving economic prospects and diminishing uncertainty usually help
unleash this pent-up demand. This upward demand pressure is often
augmented by lower interest rates, to which housing demand is typically
quite responsive.

The current economic recovery has not followed this script, in part
because the problems in the housing market are a cause of the downturn
as well as a consequence of it. The extraordinary fall in national house
prices has resulted in $7 trillion in lost home equity, more than half
the amount that prevailed in early 2006. This substantial blow to
household wealth has significantly weakened household spending and
consumer confidence. Another result of the fall in house prices is that
around 12 million households are now underwater on their mortgages
–that is, they owe more on their mortgages than their homes are worth.
Without equity in their homes, many households who have experienced
hardships, such as unemployment or unexpected illness, have been unable
to resolve mortgage payment problems through refinancing their mortgages
or selling their homes. The resulting mortgage delinquencies have ended
in all too many cases in foreclosure, dislocation, and personal
adversity. Neighborhoods and communities have also suffered profoundly
from the onslaught of foreclosures, as the neglect and deterioration
that may accompany vacant properties makes neighborhoods less desirable
places to live and may put further downward pressure on house prices.

An ongoing imbalance between supply and demand exacerbates these
problems in the housing market. For the past few years, the actual and
potential supply of single-family homes for purchase has greatly
exceeded the effective demand, in part because of the large number of
homes that have come back onto the market after moving through the
foreclosure process. The elevated pace of foreclosures, unfortunately,
is likely to be sustained for quite a while and therefore will continue
to put downward pressure on home prices.

At the same time, a host of factors have been weighing on housing
demand. Many households have been reluctant or unable to purchase homes
because of concerns about their income, employment prospects, and the
future path of home prices. Tight mortgage credit conditions have also
prevented many households from purchasing homes. Although some
retrenchment in lending standards was necessary and appropriate given
the lax standards that prevailed before the crisis, current lending
practices appear to be limiting or preventing lending even to
creditworthy households.

In the paper, we discussed the benefits and costs of a variety of
policy options that have been proposed to respond to these difficult
housing issues, including increasing credit availability for households
seeking to purchase a home or to refinance an existing mortgage;
exploring the scope for further mortgage modifications, including
encouraging short sales and deeds-in-lieu of foreclosure in cases where
foreclosure cannot be avoided; and expanding the options available for
holders of foreclosed properties to dispose of their inventory
responsibly. Any policy proposals, though, will require wrestling with
difficult choices and tradeoffs, as initiatives to benefit the housing
market will likely involve shifting some of the burden of adjustment
from some parties to others.

I greatly appreciate the leadership that the Senate Banking
Committee has shown on the profound challenges facing the housing
market. For its part, the Federal Reserve will continue to use its
policy tools to support the economic recovery and carry out its dual
mandate to foster maximum employment in the context of price stability.
In its supervisory capacity, the Federal Reserve will continue to
encourage lenders to find ways to maintain prudent lending standards
while serving creditworthy borrowers.

Thank you again for inviting me to appear before you today. I would
be happy to answer any questions you may have.

** Market News International Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MFU$$$,M$$AG$,M$U$$$]