Subprime Crisis Research Council ―White Paper‖ Presentation
September 15, 2008 Hudson Institute Washington, DC
1
Subprime Crisis Research Council ―White Paper‖ Presentation
By Ashok Deo Bardhan Robert H. Edelstein Cynthia A. Kroll University of California, Berkeley
2
White Paper Objectives
• Analyze the Current Status and Historical Context for the Sub-prime Crisis • Create and Evaluate Proposed and Prospective Short-term and Long-term Policy OptionsSolutions • Indicate Important Open Research Issues
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Presentation Outline
• Overview • Subprime Crisis Status Report • Policy Prospective • Towards a Focused Research Agenda
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Elements for the Short-term and Long-term Resolution of the Subprime Crisis
• Devise Programs to Stabilize the Housing Market and Housing Finance System • Engender Housing and General Financial Market Viability • Implement Policies that Avoid Recurrence and Moral Hazards
• Prepare for Potential Wider Domestic Economic Implication of the Sub-prime Crisis
• Recognize and Plan for Potential Global Economic and Financial System Interactions
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Overview Subprime Issues
• Direct Effects – Delinquencies – Foreclosures – home prices Lender Industry and Secondary Market Behavior – New Profit Model – Underwriting Standards – Fee Structures – Accessibility of Secondary Market Risk Contagion Effects – New Construction – Real Estate Services – Equity Loans – Financial Institutions Global Effects – Risk Spread ―Adjustments‖ – U.S. Consumption and International Trade, World-wide Stock Market/Bond Market
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•
•
•
Subprime Crisis: Selective Status Report
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Prime Delinquency Rate Is High
At 3.2%, the prime mortgage delinquency rate is in the fourth quarter of 2007 is high and rising.
Prime Mortgage Delinquency Rate 2007Q4
3.40 3.20
3.00
Percentage Points
2.80
2.60
2.40
2.20
Source: MBA
2.00 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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Sub-Prime Delinquency Rate Defies Superlatives
The sub-prime delinquency rate has pushed up past 17%.
Sub-Prime Mortgage Delinquency Rate 2007Q4
18.00 17.00
16.00
Percentage Points of Number
15.00
14.00
13.00
12.00
11.00
Source: MBA
10.00 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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Foreclosure Rate Is Rising Rapidly
Foreclosures started in the fourth quarter represent 83 basis points of all outstanding mortgages. This is a quarterly rate.
Foreclosures Started 2007Q4
0.90 0.80
0.70
Percentage Points Quarterly Rate
0.60
0.50
0.40
0.30
0.20
0.10
Source: Mortgage Bankers Association
0.00
19 79 19 80 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07
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Why Were We So Susceptible to the Subprime Crisis?
• • • • Diminution of Underwriting Quality Inexperience of Owner-Borrowers Financial ―Wizardry‖ Aggressive, Risk-Taking Investors
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Percent of Loan Value Low-Doc or No-Doc 2000 Q1 to 2007 Q2
80% 70% 60% 50% 40% 30% 20% 10% 0%
Q12000 Q32000 Q12001 Q32001 Q12002 Q32002 Q12003 Q32003 Q12004 Q32004 Q12005 Q32005 Q12006 Q32006 Q12007 Q32007
No Doc Low Doc
Source: Bardhan, Edelstein and Kroll using First American CoreLogic Marketing Reports, Loan Performance data, May 2008.
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Home Ownership Rates
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Decomposition of Change in Number of Home Owners: a) Natural Growth of Households, vs. b) Pure Growth of Ownership Rate: 2000-2007
Due to increase in ownership rate
800 700 600 500 400 300 1,000 200 100 0 -100 -200 -300 500 0 -500 -1,000 -1,500
HH Formation
3,500 3,000 2,500 2,000 1,500
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75
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Source: ACS and Census
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How Exposed Are We?
• Total US housing stock is 128 million units • Annual sales since 2000 represent between 4-6% of stock • States with high levels of price declines account for a large share of housing stock; and larger share of mortgages outstanding • Nationwide, the ability to buy a home has not changed dramatically, but regional variations show large areas of vulnerability • Subprime loans are 12 percent of all outstanding mortgages
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US Annual Sales, Existing Homes
Source: California Association of Realtors; National Association of Realtors, US Bureau of the Census
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Sales to Households Ratio
Sales per Thousand Households Source: Census, NAR
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States with Largest Loss in Home Value from Peak to Q2 2008
Change in OFHEO index, peak to Q208
0% -2% -4% -6% -8% -10% -12% -14% -16% -18% -20% CA NV FL AZ MI RI MA DC MD NJ
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Source: Bardhan, Edelstein and Kroll from OFHEO data.
Per Capita Income and Home Price Indices Compared, US, 1975-2008
700 600 500 400 300 200 100 0
Source: Indices created by authors using Office of Federal Housing Enterprise Oversight index (adjusted to 1975 base); US Bureau of Economic Analysis data.
19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07
OFHEO index Per Capita Income Index
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Per Capita Income and Home Price Indices Compared, Far West, 1975-2008
1600 1400 1200 1000 800 600 400 200 0
Source: Indices created by authors using Office of Federal Housing Enterprise Oversight index (adjusted to 1975 base); US Bureau of Economic Analysis data.
19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07
OFHEO index Per Capita Income Index
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Understanding Variation in Exposure and Experience Can Help Shape Policy
• Wide variation within the US in housing markets (median 2007 home value ranges from $88,000 in Mississippi to $536,000 in California) • Wide variation in exposure to subprime loans (low of 6% in South Dakota, high of 20% in Nevada) • Share of subprimes in foreclosure range from 3% in Utah to 18% in Michigan • Factors, such as age, household size, ownership rates, and government regulation, can influence the level and outcome of exposure.
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Selected Ownership Rates by State: 2006
Highest Lowest
Greatest increase in ownership rates: Vermont, New Hampshire, Hawaii
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Share of Subprime in Total Mortgages Outstanding: Top Ten States
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Share of all Mortgages in Foreclosure 4Q 2007: Top ten states
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Cross-State Regression Results: Determinants of Subprime Share in Total Mortgages
• Negatively related to median age • Positively related to home price and price growth rate, and minority population • Negatively related to per capita income • Negatively related to state regulatory proxies (financial administrative expenditures; state employment, etc.)
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Cross-State Regression Results: Determinants of Foreclosure Share in Total Mortgages • Foreclosures related to earlier subprime share • Negatively Related to Regulatory Stance • Positively related to Minority Share and Age • Complex relationship between subprime share and foreclosure share on one hand, and home price change and age on the other
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Dependent Variable: SUBPRIMESHARE2005 Method: Least Squares Date: 09/11/08 Time: 11:52 Sample (adjusted): 1 51 Included observations: 51 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C MEDIANAGE MEDIANHOMEPRICE
0.405437 -0.004883 2.15E-07
0.084594 0.002251 6.21E-08
4.792751 -2.169288 3.457636
0.0000 0.0353 0.0012
PERCAPINCOME
EXPFINADMINPERCAP
-1.74E-06
-0.000312
1.20E-06
9.33E-05
-1.447246
-3.338814
0.1546
0.0017
R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat
0.377095 0.322929 0.033796 0.052538 103.0241 2.028090
Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic)
0.169196 0.041072 -3.844082 -3.654687 6.961877 0.000181
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Dependent Variable: SHAREALLMORTGFC4Q07 Method: Least Squares Date: 09/11/08 Time: 11:00 Sample (adjusted): 1 51 Included observations: 51 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C SUBPRIMESHARE2Q07 EXPFINADMINPERCAP HOMEPRCHGOFHEO MEDIANAGE
-0.048532 0.158031 1.45E-05 -0.007125 0.001185
0.015936 0.026700 1.66E-05 0.002758 0.000377
-3.045429 5.918826 0.875280 -2.583392 3.140457
0.0038 0.0000 0.3860 0.0130 0.0029
R-squared Adjusted R-squared S.E. of regression
0.477226 0.431768 0.005314
Mean dependent var S.D. dependent var Akaike info criterion
0.014410 0.007050 -7.543936
Sum squared resid
Log likelihood Durbin-Watson stat
0.001299
197.3704 1.522456
Schwarz criterion
F-statistic Prob(F-statistic)
-7.354541
10.49804 0.000004
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SHAREALLMORTGFC4Q07 vs. SUBPRIMESHARE2005 .036 .032
SHAREALLMORTGFC4Q07
.028 .024 .020 .016 .012 .008 .004 .08
.12
.16
.20
.24
.28
SUBPRIMESHARE2005
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SHAREALLMORTGFC4Q07 vs. SUBPRIMESHARE2Q07 .036 .032
SHAREALLMORTGFC4Q07
.028 .024 .020 .016 .012 .008 .004 .04
.08
.12
.16
.20
.24
SUBPRIMESHARE2Q07
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SUBPRIMESHARE2005 vs. EXPFINADMINPERCAP .28
SUBPRIMESHARE2005
.24
.20
.16
.12
.08 40 80 120 160 200 240 280 320 360 EXPFINADMINPERCAP
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SUBPRIMESHARE4Q07 vs. EXPFINADMINPERCAP .24
SUBPRIMESHARE4Q07
.20
.16
.12
.08
.04 40 80 120 160 200 240 280 320 360 EXPFINADMINPERCAP
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Subprime and Alt A Mortgage Originations— Value and Share of Total Originations
700 600 40% 35% 30% 25% 20% 300 200 100 0 2001 2002 2003
Subprime
Billions of Dollars
500 400
15% 10% 5% 0% 2004
Alt A
2005
Share Subprime/Alt A
2006
2007
Source: Inside Mortgage Finance, May 2008.
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FHA Loan Program: 2008-2011 Subprime Vulnerability—CBO Estimate
# of Subprime + Alt A Loans— 11 million loans/$2 trillion value ↓ Share Owner Occupied = 9 million borrowers ↓ Failure Rate = f(income, home value, CBO assumes 25%, or 2.2 million complications due to 2nd liens = 1.5 million
-↓
→
Ineligible Borrowers = 1.1 million
-↓
→
Lenders choosing alternative route = 0.4 million
-↓
400,000 loans X $170,000/loan = $68 billion in loan authority through 2011
Source: CBO cost estimates April, June and July 2008.
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Some Troubling Conclusions
• Regional differences are significant? • Ownership at what social costs? • Credit tightening needs to be selective, especially where economies are weak?
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Developing a Policy Prospective
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Policy Objectives
• Stability in Housing Market
– Retaining high home ownership rates – Arresting drastic value slide – Maintaining ownership incentives for households with negative equity – Normalizing new and existing market activity
• Liquidity in Mortgage Market
– Stabilizing financial markets – Efficient securitization – Reorganizing Fannie and Freddie to be viable entities (at low social costs)
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Framework for Response
• Short Term
– Housing market
• Loan workout process • Stabilize home prices
– Mortgage market
• Underwrite financial system • Demand appropriate upside reward for risks taken • Dilute existing equity and debt participants fairly
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Framework for Response
• Long Term
– Housing market
• Rebalance renter and homeowner subsidies • Develop revised standards for ―subprime‖ low income borrowers (based on repayment experience)
– Mortgage market
• Reduce moral hazard and adverse selection by synchronizing cash flow with longer term outcomes • Expand regulation of financial markets
– Insurance funds – Underwriting standards – Capital requirements
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Housing Market Recovery Strategies
Debt Forgiveness Act
IRS
Tax Credit
Borrowers
Increase entry level demand Rate, term adj
Potential Home Buyers
FHA
Goal Stabilize Housing Market
Lenders/ Servicers
Securitizers
Support workouts, reestab market
GSEs
Emergency support
Treasury Dept
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Credit Market Recovery Strategies
Borrowers
Debt Forgiveness Act
IRS
FHA
HOPE NOW
↑ demand FHFA Goal Credit Market Liquidity
Potential Home Buyers
Rate, term adj
Lenders/ Servicers GSEs
Securitizers
Support workouts
Emergency support
Treasury Dept
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Whose Problem?
• • • • • • • • • • • Homeowners/Borrowers Homebuyers Home-sellers Builders Lenders Securitizers Investors Regulators Taxpayers Government sector International Components
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Policy Evaluation Criteria/Benchmarks
• • • • • • Moral Hazard Issue or Chance of Recurrence Fairness and Equity Bang for the Buck (Efficiency) ―Good‖ vs. ―Bad‖ Subprime Loans Distributional (Income and Geographic) Impact Linkages of Housing finance System with Broader Financial System and Economy
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Policy Tool Kit
• • • • • • • • Subsidies (Owners, lenders/originators) Regulatory Intervention (state/federal) Persuasion (Haircuts?) Coordination Liquidity/Funding Taxation Counseling Special Incentives – e.g. skin in the game requirement
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The Secondary Market Enigma
1. 2. 3. 4. 5. FNMA and FHLMC FDIC and Banks IB and Securitization Monoline Insurers CDS
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Real Sector Constraints for Policy
• • • • Economic Environment Job Creation Household Formation Wage Growth Prospects
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Institutions Covered by FDIC, by Risk Category (Share of Assessment Base)
4% 2% 7% Risk Level I (5BP) Risk Level I (5.01-6) Risk Level I (6.01-6.99) Risk Level I (7) Risk Levels II-IV (10-43)
30%
57%
Total Assessment Base: $6.88 Trillion Source: http://www.fdic.gov/about/strategic/report/2007highlight/mgmt_dna.html
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Impact Evaluation Matrix
Participants/Criteria Policies
Homeowner/ Borrower
House Bill Shared Appreciation Licensing etc. Bankruptcy Bill Private sector proposals
Originator
FNMA & FHLMC
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Targeting Policy
• Economic Slow-downs • Credit Tightening • Loss of Confidence in System
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Policy Perspective
• No Single Policy is the Silver Bullet • Complex Benefits-Costs Require Multi-faceted Solutions • Regional-State Differences Require Regionally Differentiated Approaches • Reinvigorate Securitization Process • Triage ―Bad‖ Loans
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Selected Open Research Issues
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Expanded Academic Research for Policy Implementation
• Why are there large regional differences in mortgage performance? • What is the significance of state regulatory systems?
• How are age-income-ethnic characteristics related to ownership, and loan issuance and performance?
• How important are distorting incentives (Fee structure; ratings agencies)? • How extensive are risk externalities?
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How Can We Explain Local-State and Regional Mortgage Performance Differences?
• Housing Market Differences • State Regulatory Behavior • State-Regional Economic Industrial Organization Impacts
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How are Ownership and Loan Performance Related to Household Characteristics?
• Ownership Rates, Income, Age and Ethnicity • Loan Issuance and Household Characteristics • Loan Performance and Household Features
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How Important Are Risk Externalities Generated By the Housing Market – Subprime Financial Crisis?
• Linkages between Housing Market and Housing Financial System • Real Sectors – Financial Sectors Interactions • Potential Complex Geographic Contagion Effects (Local, State, National, International)
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What Role Did ―Incentives‖ Play in Lending Behavior
• Fee Structures, Moral Hazard and Adverse Selection • Rating Agency Gate-keeping • Investor Perceptions
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Does State and Local Regulatory Behavior Affect Loan Behavior?
• Borrower Oriented Programs • Employment-Income Programs • Financial Institution Monitoring and Control
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