Fed Voices Concern Over Chronic Weakness in Real Estate Markets

Ongoing deterioration in real estate markets and rising levels of distressed residential and commercial properties are areas of acute concern for officials at the ""Federal Reserve"":http://www.federalreserve.gov.

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""[R]eal estate conditions have remained weak and adversely affected the performance of many banks,"" Michael R. Foley, senior associate director of the division of banking supervision and regulation at the Federal Reserve, told lawmakers Thursday.

In testimony before the Senate Subcommittee on Financial Institutions and Consumer Protection, Foley said the property markets continue to present challenges for both banks and their supervisors.

""With housing values flat or deteriorating in many markets, there are renewed concerns about the health of the mortgage market and home equity loans in particular,"" Foley said.

In the commercial sector too, ""weak fundamentals… including high vacancy rates and declining rents, continue to place pressure on all but the highest quality properties with strong tenants,"" according to Foley.

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With residential and commercial property values still under strain, he says heightened levels of reserves are necessary for banks.

""[W]e expect that banks will continue to incur losses,"" Foley said. ""It will take time to make progress on the overhang of distressed commercial and residential real estate.""

Banks will need to take strong steps to ensure that losses are recognized in a timely manner, and that reserves and capital levels remain adequate, according to Foley.

""[R]esidential and commercial real estate remain lagging sectors,"" he said.

It's a matter of paying for past mistakes, as far as Foley is concerned, but he says it started with firms outside the banking realm.

The financial crisis revealed ""critical vulnerabilities"" in both the regulatory framework and the financial system as a whole, he told lawmakers.

""In the years before the crisis, non-bank financial entities proliferated by exploiting gaps in the regulatory framework,"" Foley testified. ""This occurred during a period of increasing asset prices and abundant capital and liquidity, which eventually led to a relaxing of underwriting standards, deterioration in risk- management practices, and rapid growth of complex and opaque financial products for both consumers and investors.""

With these deficiencies exposed, Foley says Congress stepped in with the Dodd-Frank Reform Act.

The far-reaching legislation calls for 387 sets of rules and regulations to be put into place. Over half have yet to be developed, and as a result, some federal agencies have already warned that ""implementation will be pushed out"":http://www.themreport.com/articles/cftc-delays-dodd-frank-implementation-2011-06-16 by several months.