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Recap of the housing crisis, and review of a few subprime myths and facts

Quick look at the current state of the housing markets

Review the macroeconomic backdrop to housing

Primer on recent Federal Reserve actions

The subprime population is too high risk, and should not get mortgages Historical default rates for subprime about 2% in US

Subprime mortgages are “exotic”: Option-ARMs, Neg-Ams, IO, etc.—we should stay away from such predatory products NO: In fact, VERY FEW of subprimes were this type of

mortgage Almost all were 2/28 or 3/27 ARMS

OK, but that’s why they defaulted—the ARM resets! NO: Little or no evidence of any reset effect (In fact, many reset to lower interest rates)

Securitization was a bad idea—Subprime MBS securities all lost huge amounts, and were a dumb idea NO: In fact, losses on AAA “vanilla” MBS < 10%

Source: Mortgage Bankers Association, Haver Analytics

Normal times: subprime rates are

higher, but manageable

Crisis times:Everyone is

in a mess

• No link between reset date and default

• Defaults increased in 2007/8—because house prices fell, unemployment rose

• Thus the rapid increase in prime defaults as well (not shown)

Source: Foote and Willen (2012)

Losses less than 10% on AAAWhy: Credit protection worked

Losses much worse on CDOs

Foote and Willen (2012)Private label RMBS

Better—permits are rising, inventories are lean

Source: Census Bureau, Haver Analytics

Prices are flattening or turning up modestly

Source: FHFA, Core Logic, Haver Analytics

Vacancies have improved nationwide (less so in VT, NH)

Still a lot of REO/property held off the market

Source: Census Bureau, Haver Analytics

Source: Bureau of Labor Statistics, Haver Analytics

Recession ends

Source: Bureau of Labor Statistics, Haver Analytics

Recession ends

Source: Bureau of Labor Statistics, Haver Analytics

Source: Bureau of Labor Statistics, Haver Analytics

Source: Bureau of Economic Analysis, Haver Analytics

Consumer spending has been fair to middling, given overall strength

And you know about housing!

Source: Bureau of Economic Analysis, Haver Analytics

Source: Census Bureau, Michigan Survey Research Center, Federal Reserve Board, Haver Analytics

Household wealth has improved a bit (housing values, stock market)

The “fiscal cliff” matters less to households?

But it matters to businesses

The global slowdown affects export-dependent businesses, consumers less so

Source: Bureau of Economic Analysis, Haver Analytics

“Fiscal Cliff” risksCategory Magnitude

“Bush Tax Cuts” (income, estate, AMT)

$221B

Payroll Tax cut expiration $95B

Sequestration spending cuts $65B

Expiration of unemp. benefits $26B

Other changes (war drawdown, discretionary spending cuts, deprec. allowance)

$303B

TOTAL $710B=4.6% of GDP

Overall effect on GDP growth ~2.5 pctg. points

Source: Congressional Budget Office, author’s calculations

Source: Wall Street Journal, Haver Analytics

Congressionally-mandated goals(Dual Mandate)

Federal Funds rate

(overnight bank rate)

Primary policy instrument

QE“Forward

Guidance”

Alternative Policy Instruments

X

Long-term interest

rates, stock prices,

exchange rate

We buy long-term assets Removes them

from circulation in private markets

But private agents still want them

So they’re willing to accept them for a lower yield

Bottom line: we’re trying to reduce long-term rates

Fed’s SecuritiesPrivate Markets’

Securities

The recovery has been frustratingly slow Our tools to address weakness are

somewhat limited But we are doing what we can Recently, we have paid particular

attention to employment shortfalls Not because we don’t care about inflation But because the gap between the goal for

employment is so large