1. Dr. Eileen Mauskopf, Federal Reserve Board Prepared for the CDFI conference in Washington, D.C. on March 2, 2010 Disclaimer: The views presented here are my own and may or may not be shared by others in the Federal Reserve System

2.  Moderate recovery in economic activity over 2010 and 2011; recovery modest by historical standards. Expect the unemployment rate to decline, but remain over 8 percent over next two years.  Core inflation should only be around 1 percent in each of the next two years, because high unemployment rate and relatively low capacity utilization will keep wage and price increases in check.  Monetary policy should remain accommodative for the foreseeable future. ◦ The federal funds rate would not be expected to rise from its current rate of near zero for some time. ◦ Nonconventional monetary policy – the Federal Reserve’s purchase of Mortgage- backed securities and Treasury securities – expected to expire very soon.  Much depends on continued normalization of credit markets and return to job growth.

3.  Conditions in most financial markets continue to improve, particularly for large firms that can issue bonds.  But, the overall debt of the private, domestic, nonfinancial sector (households and business) contracted through the end of last year; not yet materially expanding so far this year.  Contraction of overall debt reflects a sharp contraction in bank loans.  Reflects both lack of demand for loans, and constraints on access to bank credit.  Small firms are particularly vulnerable to credit constraints at banks; do not have access to other financial markets.  Household debt barely growing. Partly reflects lower demand. But, also access to consumer loans and residential real estate loans limited by the more stringent lending standards of banks.

4.  Bank loans to business have been falling since the first quarter of 2009. Contraction is accelerating incommercial real estate loans.  Decline in these loans reflects weakness in loan demand and tightening of credit standards in response to rising delinquencies.  Outside of commercial real estate sector, banks appear to have stopped tightening credit standards (FICO score, Moody’s credit risk calculator).  However, terms on loans (interest rate, size of loan, down- payment, collateral requirements) may still be getting tougher.

5.  Bank loans to small business contracted sharply over 2009, in C&I loans, commercial real estate and credit card lending.  Weakened demand for loans as well as tightened loan standards and terms. Weak sales cited by small firms (NFIB) as most important problem in current economic situation (rather than inability to get credit)  Special factors about small business borrowing: ◦ finances of small businesses intertwined with the personal finances of their owners who use personal assets to guarantee or collateralize loans for their business. ◦ As banks failed or merged, or sought to reduce their loan portfolios (in favor of nonrisky securities), banking relationships with customers may have broken. ◦ Some banks may have become overly conservative about lending to small business.  Policy actions to support small business borrowing: Federal Reserve established a program (TALF) that sought to increase loans made to small business and consumers. FED lent money to those financial institutions who bought securities backed by small business loans, auto loans, student loans, and credit cards.

6.  Still expect banks to move cautiously in extending loans to business and to small business.  Credit quality of loans to small firms in last quarter of 2009 was worse than for large firms, so loan growth here will likely lag that for large firms.  Fed directed bank examiners not to adversely classify loans based solely on a decline in collateral value  Fed directed examiners on commercial real estate loans (which often serve as collateral for small business loans)to execute prudent workouts – when borrower is experiencing diminished operating cash flows or delays in selling the commercial property.  Obama Administration proposals: $30 billion taken from money repaid under TARP, lent to community banks to be lent to small business; $1 billion of TARP capital to CDFIs at favorable terms

7.  Decline in nonmortgage consumer debt since end of 2008. Decline intensified during the past half year.  Contraction in consumer credit due to weak demand and tight supply – reduction in credit card limits and higher interest rates on credit card debt. High delinquency rates on auto loans and credit cards.  Large portion of consumer credit funded through asset-backed securities prior to crisis. FED’s TALF program restarted this.  Even though mortgage rates are at low levels, availability of mortgage financing sharply constrained.  FHA raised insurance premiums down-payment requirements for borrowers with low credit scores.  Including decline in mortgage debt, total household debt declined (in 2008) for the first time since the Federal Reserve started collecting the data in 1951.

8.  Consumer spending financed largely out of current income over past year rather than borrowing. Personal saving rate up to about 4 percent from 1 percent just 2 years ago.  Household net worth turned up in the middle of 2009; largely due to rise in equity prices; some increase in value of owner-occupied real estate.

9.  Unemployment rate at 9.7%, up from 5 percent two years ago. 41% of total unemployed have been unemployed for 6 months or more.  Demographic groups most adversely affected are men, the young, the less-educated and minorities.  Unemployment rate expected to stay high even as economy grows. Likely drop to low to mid 9% range by end of this year; to 8% by end of 2011.

10. ◦ Why did the unemployment rate rise so much and why does it take so long to fall?  Traditional pattern of recovery in labor markets: firms first get more productivity out of their workers – perhaps by shifting them into more productive positions – before they increase the hours worked.  Over second half of 2009, relatively strong growth in output met by continued cuts in hours worked and layoffs. Huge surge in productivity.  In second stage, overtime increases raising the average workweek.  Last stage, firms hire more workers. Job losses have slowed but hiring remains weak.

11. ◦ They tend to increase hiring sooner than large firms in a recovery. ◦ Their employment is not as cyclically-sensitive as that of large firms. ◦ Thus small firm share of employment increases in downturns and in the early stages of a recovery. Tight credit conditions for small business could slow recovery in employment in current cycle. ◦ Job losses at very small firms (fewer than 50 employees) have been larger than their employment share in the current downturn, reflecting the plunge in residential construction.

12. ◦ Jobs bill (senate version): no payroll taxes on new hires who have been unemployed for prior 2 months; $1000 credit if they stay on for one year. ◦ Possible response: Because no threshold in job creation required to be met before credit is earned, may not see any impetus to job creation. ◦ In addition, onerous paperwork may lead to firms’ not bothering with this plan. ◦ Many believe that creating strong demand is the best way to create sustainable job growth.

13.  Housing market (sales and construction) began to recover in spring of 2009, but pace of improvement slowed in recent months.  House prices have stopped falling, but could see downward pressure on home prices resume when homes in delinquency and foreclosure pipeline hit inventories.  About ¼ of all homes underwater.  Negative equity and high unemployment rate push up delinquency rates. As of December, 16% of prime variable rate mortgages are delinquent and over 5% of prime fixed rate mortgages are delinquent. 35% of all subprime loans delinquent.  1.4 million homes entered foreclosure pipeline during second half of 2009.

14.  Favor those with negative equity and relatively small hit to income  Very generous modifications to mortgage terms if qualify  Those least likely to qualify are those who have owned their homes for a long enough time to have paid down their mortgages; those with relatively low LTVs have a harder time qualifying.