Banks, financial system adjusted to postcrisis realities
The financial system made significant progress in general in 2011 but has yet to recover completely. As the year ended, the housing sector was still weak and posed a significant hindrance to the health of the financial system. For the year as a whole, sales of new homes were at their lowest level since the federal government began keeping records in 1963. Homes in foreclosure continued to clog the market and exert downward pressure on house prices.
Policymakers have developed several programs to try to restore the health of the housing market since the mortgage crisis began. So far, these housing relief programs have had limited success. For example, in 2009, the Federal Housing Finance Agency (FHFA) introduced the Home Affordable Refinance Program (HARP). This program was intended to allow qualified borrowers with mortgages owned or backed by one of the government-sponsored enterprises to refinance, even if these borrowers would not qualify for a traditional refinance. The FHFA hoped that HARP would reach 5 million homeowners. However, by the end of 2011, only about 1 million mortgages had been refinanced through HARP. Housing experts suggest the relatively low participation rate can be partly attributed to lender worries about GSE putback risks. The Home Affordable Modification Program (HAMP) is a federal program created to help financially struggling borrowers lower their monthly payments rather than refinance their mortgages. HAMP also has had only moderate success. Policymakers continue to debate and discuss relief programs that could bolster the housing market and spur economic growth.
Some bright spots appeared last year despite the generally depressed state of the housing market. At the end of December, the national inventory of homes for sale stood at just over a six-month supply, down from a high of 11 months in the third quarter of 2010, according to the National Association of Realtors. Such a decline must occur before the housing market can improve. A supply of about six months is generally considered the market's equilibrium. See the chart.
Banks' efforts to repair their balance sheets took place in a challenging environment. Consolidation in the industry continued throughout 2011. At year's end, the Federal Deposit Insurance Corporation (FDIC) was insuring some 7,400 institutions—about 300 fewer than it had insured a year earlier. Some banks failed outright. Others merged—the FDIC listed almost 200 bank mergers during the year, about a 15 percent increase from the number that occurred in 2010.
Banks were also adapting to the first full year of regulatory reform after Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. Key elements of this large and complex legislation were intended to enhance financial stability; reduce taxpayer exposure to losses from failing financial institutions, including preventing "too big to fail" occurrences; strengthen consumer protection; and strengthen investor protection.
The Federal Reserve and other federal financial regulators were in the early stages of formulating and implementing regulations under the act. Striking the right regulatory balance was and continues to be critical, said Michael Johnson, senior vice president and head of the Atlanta Fed's Supervision and Regulation Division. See the video. The Fed, along with the other regulatory agencies, worked to ensure as much as possible the safety and soundness of the financial system without crippling the ability of financial institutions to make a profit.
As Federal Reserve Governor Daniel Tarullo explained in testimony before the Senate in December 2011, such efforts mean "implementing the [Dodd-Frank] statute faithfully, in a manner that maximizes financial stability and other social benefits at the least cost to credit availability and economic growth." To that end, Federal Reserve teams of supervisors, legal staff, economists, and other specialists worked to develop practical rules and to avoid unintended consequences of regulation. In particular, the Federal Reserve tried to minimize the regulatory burden on smaller financial institutions.
"It's a multiyear process," Johnson said of implementing a new regulatory regime. "It's still very much in the early stages."
Finally, smaller banks especially were trying to adjust their business models by reducing their reliance on lending secured by real estate. As small banks worked to diversify away from real estate lending, they faced a new challenge, as the demand for loans from businesses and consumers was not strong in 2011.
In the fourth quarter of the year, annualized loan growth for all commercial banks was 7.8 percent. However, the loan volume of smaller banks had shrunk by about 1.7 percent while larger banks had experienced annualized growth of 10.4 percent, according to data compiled from bank call reports filed with regulatory agencies.
Meanwhile, issuance of consumer asset-backed securities (ABS) was relatively unchanged from 2010 See the chart. New auto ABS continued to experience issuance close to precrisis levels, increasing from about $58 billion in 2010 to about $68 billion in 2011. Credit card and student loan securitizations remained subdued. The slow pace of credit card ABS issuance is consistent with the broader trend of consumers paring down their debts. (See the section on household deleveraging.)
The financial system generally—and the banking sector particularly—made progress on balance sheet repair during 2011, but did not return to full strength.