Fed's Kroszner: parts of mortgage market stalled

Federal Reserve Governor Randall Kroszner in an undated photo. Strains in financial markets have eased somewhat but securitizations of non-agency mortgage products remain stalled and will recover only gradually, Kroszner said on Friday.

NEWTON, Mass (Reuters) - Strains in financial markets have eased somewhat but the bundling of mortgages into securities by Wall Street firms is stagnant and will recover only gradually, Federal Reserve Governor Randall Kroszner said on Friday.

Kroszner said additional capital raising by financial institutions would support lending to households and businesses, which would boost the economy.

"Strains continue to result in restrictive conditions for home-mortgage borrowers," Kroszner said at a finance conference hosted by Boston College.

Investors will only buy bundles of the smaller mortgages that conform to the standards of government-sponsored housing finance companies such as Fannie Mae, Kroszner said, preventing lenders from freeing up capital by selling their largest home loans.

"New originations are being held in lenders' portfolios, pressuring their balance sheets and, for example, leaving the spread between interest rates offered on jumbo and conforming mortgages very high," he said.

Difficult conditions in mortgage securitization markets put strains on the housing market itself, Kroszner said.

Kroszner said housing markets will recover only slowly because of large numbers of unsold homes in parts of the country.

"It will take time, I think, given these historically high inventory numbers for the nation as a whole," he said in response to questions.

U.S. financial markets have been in turmoil since last summer after a surge in mortgage delinquencies due to falling house prices and rising interest rates. The Fed has slashed interest rates by 3.25 percentage points to 2 percent since September and flooded financial markets with billions of dollars of liquid funds to ease strains and put a floor under the slowing economy.

Kroszner said the "tenor" in financial markets has generally improved this spring, with spreads between yields on corporate bonds and Treasury securities narrower than in March. He said in May alone, domestic nonfinancial corporations were able to raise more than $50 billion in the bond market.

U.S. bank holding companies have raised more than $80 billion in capital this year.

"Financial institutions should continue in their efforts to raise capital," he said, adding that this would provide a more solid footing for the broader economy.

Kroszner said stronger risk management practices will help contribute to the recovery of mortgage markets, along with greater transparency and less complexity in credit instruments.

"Financial institutions that develop and hold these instruments and that have similar or correlated exposures through various business lines should also strengthen risk-management practices," he said. "And supervisors of these institutions must insist on effective risk management and take the steps necessary to ensure that changes are implemented where needed."

(Writing by David Lawder; Editing by Tom Hals)