also observed that lenders are increasingly combining nontraditional mortgage loans with weaker mitigating controls on credit exposures - - for example, by accepting less documentation in evaluating an applicant's creditworthiness and not evaluating the borrower's ability to meet increasing monthly payments when amortization begins or when interest rates rise. these " risk layering " practices have become more and more prevalent in mortgage originations. thus, while some banks may have used elements of the product structure successfully in the past, the easing of traditional underwriting controls and sales of products to subprime borrowers may have unforeseen effects on losses realized in these products. in view of these industry trends, the federal reserve and the other banking agencies decided to issue the draft guidance on nontraditional mortgage products. the proposed guidance emphasizes that an institution's risk - management processes should allow it to adequately identify, measure, monitor, and control the risk associated with these products. it reminds lenders of the importance of assessing a borrower's ability to repay the loan including when amortization begins and interest rates rise. these products warrant strong risk - management standards as well as appropriate capital and loan - loss reserves. further, bankers should consider the impact of prepayment penalties for arms. lenders should provide borrowers with enough information to clearly understand, before choosing a product or payment option, the terms of and risks associated with these loans, particularly the extent to which monthly payments may rise and that negative amortization may increase the amount owed above the amount originally borrowed. lenders should recognize that certain nontraditional mortgage loans are untested in a stressed environment ; for instance, nontraditional mortgage loans to investors that rely on collateral values could be particularly affected by a housing price decline. investors have represented an unusually large share of home purchases in the last two years. past loan performance indicated that investors are more likely to default on a loan when housing prices decline, than owner occupants. ongoing efforts to update and improve the market risk amendment let me now describe the changes that are occurring in market risk capital. while only banks with large trading books hold capital for market risk, the issues that the proposed changes are designed to address can be considered by treasurers, asset / liability managers, and traders to determine whether their risk management practices are keeping pace with the changing nature of risks. as you are no doubt aware, about a decade ago the u. s. banking agencies developed regulatory capital requirements specifically

deteriorated significantly over the past two years or so. the virtual shutdown of the subprime mortgage market and a widening of spreads on jumbo mortgage loans have further reduced the demand for housing, while foreclosures are adding to the already - elevated inventory of unsold homes. new home sales and housing starts have both fallen by about half from their respective peaks. the number of homes in inventory has begun to edge down, but at the current sales pace the months'supply of new homes has continued to climb, and home prices are falling in many parts of the country. the slowing in residential construction, which subtracted about 1 percentage point from the growth rate of real gross domestic product in the third quarter of 2007, likely curtailed growth even more in the fourth quarter, and it may continue to be a drag on growth for a good part of this year as well. recently, incoming information has suggested that the baseline outlook for real activity in 2008 has worsened and that the downside risks to growth have become more pronounced. in particular, a number of factors, including continuing increases in energy prices, lower equity prices, and softening home values, seem likely to weigh on consumer spending as we move into 2008. consumer spending also depends importantly on the state of the labor market, as wages and salaries are the primary source of income for most households. labor market conditions in december were disappointing ; the unemployment rate increased 0. 3 percentage point, to 5. 0 percent from 4. 7 percent in november, and private payroll employment declined. employment in residential construction posted another substantial reduction, and employment in manufacturing and retail trade also decreased significantly. employment in services continued to grow, but at a slower pace in december than in earlier months. it would be a mistake to read too much into one month's data. however, developments in the labor market will bear close attention. in the business sector, investment in equipment and software appears to have been sluggish in the fourth quarter, while nonresidential construction grew briskly. in light of the softening in economic activity and the adverse developments in credit markets, growth in both types of investment spending seems likely to slow in coming months. outside the united states, however, economic activity in our major trading partners has continued to expand vigorously. u. s. exports will likely continue to grow at a healthy pace in coming quarters, providing some impetus to the domestic economy. financial conditions continue to pose a downside risk to the outlook. market