ben s bernanke : the future of mortgage finance in the united states speech by mr ben s bernanke, chairman of the board of governors of the us federal reserve system, at the uc berkeley / ucla symposium : “ the mortgage meltdown, the economy, and public policy ”, berkeley, california, 31 october 2008. * * * i appreciate the opportunity to speak at this symposium. my remarks will focus on the mortgage securitization process, how it has been affected by the financial crisis, and how it may evolve in response to this crisis. in the united states, as you know, mortgage securitization has been dominated by two government - sponsored enterprises ( gses ), fannie mae and freddie mac, as well as by the combination of the federal housing administration ( fha ) and ginnie mae. by contrast, private - label securitization became a significant presence in mortgage securitization only during the past decade, motivated in part by developments in financial engineering. the financial crisis has upset the linkage between mortgage borrowers and capital markets and has revealed a number of important problems in our system of mortgage finance, including weaknesses in the structure and oversight of the gses and perhaps in the originate - to - distribute model of credit provision itself. private - label securitization has largely stopped, and fannie and freddie were placed into conservatorship by their regulator after they were judged to be operating in an unsafe and unsound manner. our task now is to begin thinking about how to best reestablish a link between homebuyers and capital markets in a way that addresses the weaknesses of the old system. in light of the central role that the gses played, and still play, any such analysis must pay particular attention to how those institutions should evolve. the mortgage market and mortgage securitization in the financial crisis the financial crisis that began in august 2007 has entered its second year. its proximate cause was the end of the u. s. housing boom, which revealed serious deficiencies in the underwriting and credit rating of some mortgages, particularly subprime mortgages with adjustable interest rates. as subsequent events demonstrated, however, the boom in subprime mortgage lending was only a part of a much broader credit boom characterized by an underpricing of risk, excessive leverage, and the creation of complex and opaque financial instruments that proved fragile under stress. the unwinding of these

1 standard ” - - that is, to hold enough liquid resources in all relevant currencies to make payments on time in the event of the default of the clearing member that would generate the largest payment obligation under a wide range of potential stress scenarios. more complex ccps and those with a systemic presence in multiple jurisdictions are encouraged to meet a “ cover 2 standard. ” the pfmi also provide guidance on the resources that qualify in meeting these requirements : cash held at a central bank or a creditworthy commercial bank, committed lines of credit, committed repurchase agreements, committed fx swap agreements, or highly marketable collateral that can be converted into cash under prearranged and highly reliable funding arrangements. there are two sets of risks involved here. first, where should ccps put their cash? as central clearing has expanded, ccps have had to deal with increasingly large amounts of cash margin. ccps can deposit some of these funds with commercial banks. but regulatory changes have made it more expensive for banks to take large deposits from other financial firms, and in some cases banks may be unwilling to accept more cash from a ccp. and many of the largest banks are also clearing members, which introduces a certain amount of wrong - way risk. a clearing - member default could be especially fraught if the defaulting bank also held large cash balances for the ccp. for this reason, ccps may prudently place limits on the amount deposited at a given institution. in order to diversify their holdings, many also place cash in the repo market. if it is available, the ability to deposit cash at a central bank allows for another safe, flexible, and potentially attractive option - - a subject i will return to later. second, how can ccps be assured that they will be able to convert securities into cash or draw on other resources in times of stress? the pfmi uses the words “ committed ” and “ pre6 arranged ” in describing qualifying liquid resources. indeed, the pfmi does not view spot transactions on the open market as reliable sources of liquidity during times of stress. the federal reserve has strongly supported this approach. liquidity plans should not take for granted that, at a time of stress involving a member default, lines of credit, repurchase agreements, or fx swaps could be arranged on the spot. committed sources of liquidity are more likely to be available. they also allow market participants and regulators to make sure that plans