story of a fractured market for housing finance as private mortgage lending came to a standstill and new lending depended heavily on government support. the number of active mortgage companies fell 25 percent from 2006 to 2008, in part because the warehouse lines of credit that mortgage companies depended on to fund their loans contracted significantly. in addition, overall demand for housing slowed appreciably. indeed, the number of mortgage applications in 2008, 14. 2 million, was about half the 2006 level and the lowest in more than a decade. such a low level of applications suggests that potential borrowers were wary of entering the housing market or feared being turned down for a loan. the 2008 hmda data also show a dramatic increase in loans made by fha and va, whose share of total mortgage originations were higher than at any time in the 19 - year history of hmda reporting. 1 these government - backed loans have been characterized as the alternative for borrowers with a weaker credit record in the absence of a subprime market. in addition, they are presumably attractive at the moment because they are among the few affordable options for buyers with stronger credit records but only modest savings available for a down payment. in the recent past, such borrowers would have used a so - called “ piggyback ” mortgage – effectively borrowing part of the down payment – or secured private mortgage insurance to compensate for a higher loan - to - value ( ltv ) ratio. according to data from the national association of realtors, the typical first - time homebuyer over the past several years has had a down payment of less than 10 percent of the purchase price of the home. 2 securing even that much has historically been a barrier to home purchase, especially among lower - income, younger, or minority households. 3 yet higher ltv loans that help overcome this barrier also pose higher credit risk. striking the right balance in loan underwriting is critically important but has proven very difficult. the development of more flexible underwriting standards was originally hailed for the potential to help millions of families become homeowners. but at some point, a line was obviously crossed, standards were dangerously lowered, and loans were underwritten without any regard for a borrower ’ s ability to repay. when home prices fell and jobs were lost, borrowers who did not have other assets to tap were left exposed. so the question is : how can the market re - emerge with enough flexibility to allow more families to achieve homeownership in a responsible way

s board of directors should understand the bank ’ s exposure to risk, and its members should be willing and able to critically question senior management about important matters affecting those risks. in my experience, specific technical financial expertise – which may be somewhat more difficult to find in smaller communities – is not nearly as important in this regard as board members ’ ability to exercise sound and effective judgment regarding different risks confronting the bank and to take seriously their responsibility for the long - term interests of the bank. the board of directors, along with a strong senior management team, can contribute substantially to the safe and sound operation of the bank by setting the “ tone at the top ” regarding activities and behaviors that are either encouraged or frowned upon. well - informed managers and staff constitute another inner circle. customer - facing employees who know their business and know their customer base can play a critical role in catching problems at inception. and institutional knowledge of this kind is an area of relative strength for community banks. successful business lines are profitable because they are run by those who understand and can manage risk. risk is best understood, i believe, by those who are engaged in the day - to - day business of the bank. a bank in which every employee understands his or her responsibility for managing risk is likely to be more sound than a bank in which risk management is always seen as someone else ’ s responsibility. while risk management starts at the business - line level, a well - run bank also has in place an effective program for enterprise - wide risk management that is supported by strong internal controls. i know that many smaller community banks may not have the resources to establish a separate risk management function, but that is not necessarily a problem if senior bis central bankers ’ speeches management and other key personnel establish a system of internal, independent checks and balances to ensure that risks are regularly identified, controlled or otherwise managed, and monitored. these systems include not only core functions such as credit administration, effective reporting of information to senior management and the board, and policies and procedures that are documented and implemented, but also processes that try to look ahead to potential risks on the horizon. another of the inner circles is a strong internal audit function that reviews the bank ’ s operations, risk management, and internal controls. in particular, an effective internal audit function will : identify processes to be audited based on risk exposure, establish a schedule and frequency for performing internal audits, ensure that there is accountability for fixing problems identified in the audit, and escalate significant