The Subprime Crisis...LTCM Crisis Sources: Bureau of Economic Analysis/Haver Analytics, Board of...
Transcript of The Subprime Crisis...LTCM Crisis Sources: Bureau of Economic Analysis/Haver Analytics, Board of...
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
The Subprime Crisis:Can problems in a small part of the mortgage market disrupt the
entire economy?
Paul Willen
Federal Reserve Bank of Boston
REFA Meeting, December 6, 2007
The following reflects the views of the author and is neither the official position ofthe Federal Reserve Bank of Boston nor of the Federal Reserve System.
c©2007 by Paul S. Willen.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 1 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Disclaimer
The views expressed today are mine.
The do not necessarily reflect the views of
The Boston Fed
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 2 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
or the Federal Reserve System
When I say “we”, I mean members of the researchdepartment.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 3 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Caveat
Everything I’m about to say could be wrong:
Example:
Until [the depression], mortgages were not fullyamortized, as they are now..., but were ballooninstruments in which the principal was notamortized, or only partially amortized at maturity,leaving the debtor with the problem of refinancingthe balance.
Fabozzi and Modigliani (1992)
Is this true?
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 4 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Essentially no.
Mutual svgsbanks
LifeInsurers
Savingsand Loans
CommercialBanks
Individualsand Other
By type of loan (1925-1929)Fully Amortized 14.3 94.6 10.1Partially Amortized 61.5 0 38.3Non-amortized 24.1 5.1 50.3
Percentage of market (1929) 10.5 11.8 40.3 12.1 25.2As % of dollar value of all loans
Economists find a new theory...
Old theory is “wrong”, new theory is “right”
New theory will be old some day!
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 5 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Figure: Theodoric of York, Medieval Barber (and intellectual)
Why, just fifty years ago, they thought a disease like yourdaughter’s was caused by demonic possession orwitchcraft. But nowadays we know that Isabelle issuffering from an imbalance of bodily humors, perhapscaused by a toad or a small dwarf living in her stomach.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 6 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Short answer
Can problems in a small part of the mortgage market disruptthe entire economy?
Answer: No.
Because we have tools to address problems in the mortgagemarket. (Point 1)
But...
Problems in mortgage market are symptom of more seriousproblem: House prices (Point 2)House prices could derail the economyBut we believe they probably won’t. (Point 3)
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 7 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
Forecast
From Macro Advisors (ours isn’t ready yet)
Percentage change at annual rates.
2007 2008Q3 Q4 Q1 Q2 Q3 Q4
Real GDP 4.9 0.1 1.8 3 2.9 3.1Consumption 2.7 1.1 1.9 2.1 2.3 2.5Nonres. investment 9.4 5.6 3.9 5.8 5.5 5.3Residential inv. -19.7 -24.7 -15 -5.3 3.7 5.1Change in inventories 32.9 22.9 25.3 35.4 32.6 33.2Exports 18.9 3.2 6.6 7.9 9 9Imports 4.3 3.6 2.9 3.1 4.6 5.5Gov’t spending 3.9 3.2 1.8 1.8 1.9 2.1Unemployment (%) 4.7 4.8 4.9 5 5.1 5.1Core CPI 2.5 2.2 2.3 2.4 2.3 2.3
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 8 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
DisclaimerForecastOverview of analysis
HousePrices
2
3
Mortgage
MarketProblems
1CreditCrunch
Consumption
Investment
Reckless lenders, new products, mortgage resets
Problems spread
Source of problems is stagnant or falling house prices
We will focus on:1 Addressing the credit crunch2 It’s the house prices...3 The housing wealth-consumption link
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 9 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
The Credit Crunch
Paul Krugman (NYT, 9/20/2007)
It makes more funds available to depositoryinstitutions, a k a old-fashioned banks butold-fashioned banks arent where the crisis iscentered. And the Fed doesnt have any clear way todeal with bank runs on institutions that arent calledbanks.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 10 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
MortgageBorrowers
LoansNon-Bank
LendersHigh Rated
MBSInvestors
HedgeFunds
Low rated
MBS
BanksMarginCredit
Warehouselines
Loans
The Fed
“New Housing Finance System”
No banks necessary
Banks still at the center of it all!1 Margin Credit2 Warehouse lines3 Direct lending
Things came apart when sub prime borrowers stopped paying1 Cut off warehouse lines2 Cut off margin credit3 Whole system fell apart
The Fed – the lender of last resort.1 Can we get the ball rolling again?
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 11 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Forecasters have historically overestimated the impact offinancial crises.
Will we do that again?
Global Insight’s Forecast of Real GDP q-o-q, annual rate. Forecast Date
2007:Q3 2007:Q4 2008:Q1 2008:Q2 2008:Q3 2008:Q4
Aug. 2007 2.3 2.3 2.3 2.3 2.7 3.2Sept. 2007 2.3 1.7 1.5 1.8 2.6 2.7
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 12 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Some financial crises in the past
1 1970 Q2: Penn Central bankruptcy.
2 1982 Q3: Latin American defaults (e.g. Mexico) and crises incommercial banks and thrift institutions.
3 1987 Q4: Stock market crash (Black Monday).
4 1994 Q1: Bond Market Meltdown.
5 1998 Q3: Russian defaultand LTCM crisis.
6 2001 Q3: September 11th attacks in NYC and WashingtonDC.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 13 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Figure: Forecasting experience with 9/11.
Q3:2001 Q4:2001 Q1:2002 Q2:2002 Q3:2002
-3
-2
-1
0
1
2
3
4
5
6
Quarterly Percent Change, Annual Rate
Panel B
DRI Forecasts of Real GDP September 11th, 2001
Q3:2001 Q4:2001 Q1:2002 Q2:2002 Q3:2002
-3
-2
-1
0
1
2
3
4
5
6
Quarterly Percent Change, Annual Rate
Panel A
Green Book Forecasts of Real GDP September 11th, 2001
Sources: Bureau of Economic Analysis/Haver Analytics, Board of Governors, Data Resource Review/Global Insight Inc.
Actuals
Pre Crisis, 8/16/01
Crisis, 9/27/01
Actuals
Pre Crisis, 9/01
Crisis, 10/01
Post Crisis, 12/05/01
Post Crisis, 12/01
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 13 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Figure: Forecasting experience with the Russia Crisis in 1998.
Q3:1998 Q4:1998 Q1:1999 Q2:1999 Q3:1999
0
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2
3
4
5
6
7
Quarterly Percent Change, Annual Rate
Panel B
DRI Forecasts of Real GDP LTCM Crisis
Q3:1998 Q4:1998 Q1:1999 Q2:1999 Q3:1999
0
1
2
3
4
5
6
7
Quarterly Percent Change, Annual Rate
Panel A
Green Book Forecasts of Real GDP LTCM Crisis
Sources: Bureau of Economic Analysis/Haver Analytics, Board of Governors, Data Resource Review/Global Insight Inc.
Actuals
Crisis, 9/23/98
Pre Crisis, 8/13/98
Crisis, 10/98
Pre Crisis, 9/98
Actuals
Post Crisis, 12/98
Post Crisis, 12/16/98
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 13 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Figure: Forecasting experience with the 1987 stock market crash.
Q3:1987 Q4:1987 Q1:1988 Q2:1988 Q3:1988
0
1
2
3
4
5
6
7
Quarterly Percent Change, Annual Rate
Panel B
DRI Forecasts of Real GNP 1987 Stock Market Crash
Q3:1987 Q4:1987 Q1:1988 Q2:1988 Q3:1988
0
1
2
3
4
5
6
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Quarterly Percent Change, Annual Rate
Panel A
Green Book Forecasts of Real GNP 1987 Stock Market Crash
Sources: Bureau of Economic Analysis/Haver Analytics, Board of Governors, Data Resource Review/Global Insight Inc.
Pre Crisis, 9/16/87
Actuals
Crisis, 10/28/87
Crisis, 11/87
Pre Crisis, 10/87
Actuals
Post Crisis, 12/9/87
Post Crisis, 12/87
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 13 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Figure: Impulse Responses to a Liquidity Crisis
0 5 10 15 20−0.02
−0.01
0
0.01
0.02GDP
0 5 10 15 20−0.02
−0.015
−0.01
−0.005
0
0.005
0.01GDP Deflator
0 5 10 15 20
−0.1
−0.05
0
0.05
0.1Commodity Price Index
0 5 10 15 20−3
−2
−1
0
1Federal Funds Rate
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 14 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Fed response
Fed response
Banks still matter!
Fed policy tools still matter!
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 14 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
A theory (more of a story)
Conventional wisdom right now:
Lenders threw out 100 years of best practice and did stupidthings:
Reduced documentation“Exploding ARMs”
Our theory:
It’s house priceseven if they had followed reasonable guidelines, we’d still havea problem, even if not as big as the problem that we now face.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 15 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Some points
1 Defining a subprime mortgage
2 Resets aren’t the problem
3 Profile of foreclosees
4 Subprime outcomes
5 It’s the house prices
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 16 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Defining a subprime mortage
What is a subprime mortgage?
Good question:
A “subprime borrower”
Has missed a mortgage payment in the last year or two yearsHas filed for bankruptcy in the last few yearsHas a “FICO score” less than 620
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 17 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
A “subprime lender”is the only type of lender who lends to subprime borrowers.but also lends to other borrowers who want to stretch
High LTV
High DTI
Low Doc
All of the above plus subprime borrower
has a reputation as honest, trustworthy. Puts interest ofborrower first.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 18 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
A “subprime mortgage” is either
a loan made to a subprime borroweror a loan made by a subprime lender to any borrower.or some ill-defined combination of both.
Bottom line: Even defining subprime is a mess.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 19 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
LoanPerformance data
Mortgage sold in MBSLabelled “Subprime”, “Alt-A” or “Prime”
HMDA
“High cost” loans300 basis points over treasury of equivalent maturity
Warren Data
Use HUD list of “Subprime Lenders”For small sample, we can see ARM rates93% of HUD-list loans had either
margin>350 basis points
initial rate >200 basis points over equivalent prime
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 20 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Table: Subprime Lenders in Massachusetts, 1998-2007. HUD List.
# loans % of subprime statuspurchase mortgages
Option One Mtg. Corp. 11,243 18.6 operatingNew Century Financial Corp. 5,951 9.9 shutdownFreemont Investment & Loan 5,550 9.2 shutdownArgent Mtg. Co. 3,599 6.0 shutdownSummit Mtg. Co. 3,067 5.1 shutdownMortgage Lender Net 2,798 4.6 shutdownLong Beach Mtg. Co. 2,520 4.2 shutdownWMC Mtg. Corp. 2,316 3.8 shutdownAccredited Home Lenders 2,174 3.6 shutdownFirst Franklin Financial 1,896 3.1 operating
Total 41,114 68.1 -
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 21 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Conventional wisdom
Story goes something like this:
Borrower lured in by “below-market teaser”Can afford the paymentsReset hitsPayment “explodes”Delinquency
Not accurate picture.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 22 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
The “Teaser”
There is no such thing as a low teaser on subprime loan
Focus on 2/28s because
More than half of all subprime loansAlmost all the subprime ARMsDisproportionate delinquencies
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 23 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Whole country
Subprime 2/28’s
Source: LP (Prepared by the BOG)
Initial 1-yearMargin
Fully Indexed Raterate prime arm at reset at origination
2001 9.7 5.8 6.2 7.5 10.02002 8.7 4.6 6.6 8.3 8.42003 7.8 3.8 6.3 10.0 7.52004 7.3 3.9 6.1 11.3 7.92005 7.5 4.5 5.9 10.7 9.72006 8.5 5.5 6.1 10.9 11.42007 8.6 5.7 6.1 10.8 10.8
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 24 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Subprime Business Model
Extract high fees
High interest rates prior to reset
Borrowers refinances (or defaults) prior to reset.
NOT the same as credit cards.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 25 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Cumulative terminations of Subprime 2/28’s
Source: LP (prepared by BOG)
2001 2002 2003 2004 2005 2006
Still active 4.5 2.4 6.0 14.0 47.9 77.3
6 months or less 6.2 5.4 6.3 8.6 9.0 9.37 to 12 months 21.0 20.4 24.3 26.8 25.2 20.313 to 18 months 37.1 37.4 40.1 41.8 38.0 22.719 to 24 months 56.8 59.6 64.9 67.3 50.125 to 30 months 69.8 73.5 80.6 81.6 52.131 to 36 months 77.5 81.9 87.5 85.5
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 26 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Exotic Mortgages
You may have heard about exotic mortgagesInterest only and Neg-AMDo have exploding payments
Are NOT the problem right now.
Source: McDash
1 mo. 2 mo. 3+ mo. Total FICO
Option ARM 3.2% 1.2% 1.2% 5.7% 7072/28 10.0% 5.2% 6.7% 21.9% 6243/1 5.1% 2.1% 2.6% 9.9% 6845/1 1.5% 0.5% 0.5% 2.5% 7297/1 1.1% 0.3% 0.3% 1.7% 73210/1 1.0% 0.3% 0.2% 1.5% 738All IO ARMS 2.0% 0.8% 0.8% 3.6% 726All Non-IO ARMs 4.1% 1.7% 2.1% 7.9% 696
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 27 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Reset Freeze
Freeze rates at initial level for borrowers who:
can afford the initial rate.cannot afford the fully indexed rate.
Two problems:not many people
Reset is small – raises payment by 20%.
Presence of second liens means that effect on total mortgage
payment is even smaller.
Equivalent to a < 10% fall in income even for highly indebted
borrowers.
very difficult to identify these people
especially if loan was low-doc to begin with...
To me, it’s useful because it shifts the debate.
Even if we could implement it, it wouldn’t help much.Forces people to accept that resets aren’t the problem!
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 28 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
A profile of foreclosees
Actual foreclosures (not petitions)
Three facts1 Many put nothing down.2 Many owned the house for a short time3 Concentrated in LMI communities, not new construction.
Source: Warren Group.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 29 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
(.0227192,.0969305](.015261,.0227192](.0113314,.015261](.0086207,.0113314](.0066026,.0086207](.0043716,.0066026](.0025099,.0043716](0,.0025099][0,0]No data
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 30 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
(.0158353,.0551181](.0110619,.0158353](.0071971,.0110619](.0056657,.0071971](.0037559,.0056657](.0028694,.0037559](.0018939,.0028694](.0007305,.0018939][0,.0007305]No data
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 31 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Communities
Disproportionately LMI
Minority
More so than last time
LMI % of Minority Zip CodeForeclosure Ownerships Foreclosure Ownerships
2006 43.8 16.8 25 14.22007 44.2 17 25.6 14.3
1991 34.1 17.7 21.8 14.81992 38.8 17.6 23.3 14.7
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 32 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Tenure
Percentage of foreclosees with who owned the house for...
< 1 year < 2 years <3 years >3 years ≥5 years ≥ 10 years
2006 4.0 26.9 42.4 57.5 42.3 21.82007 3.1 25.8 45.1 54.9 38.8 21.1
1991 5.8 11.7 24.8 75.1 . .1992 3.2 6.6 15.3 84.6 . .
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 33 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Purchase equity
Percentage of foreclosees with LTV at purchase of...
≤ 80% 80%–95% 95%–100% ≥ 100%
2006 8.6 41.1 15.7 34.52007 8.0 38.4 13.4 40.01991 35.9 53.9 1.9 8.21992 30.4 58.0 2.7 8.8
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 34 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Role of subprime
Almost half the foreclosures involved a subprime mortgage,
But less than a third involved a house purchased with asubprime mortgage.
I.e. 70% of foreclosed properties were purchased with primemortgages.
Subprimepurchase
Subprimedefault
Default onpurchase
2006 28.7 45.6 38.62007 30.4 43.9 39.7
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 35 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Subprime outcomes
Gerardi, Shapiro and Willen (2007)
Do subprime loans lead to problems?
Look at delinquency rates on subprime loans.
Deceptive for two reasons1 Most subprime loans are refinances – people are already in
trouble when they get them. Causality goes the wrong way.2 Subprime purchase loans? Most end with refinance
Look at whole homeownership experience
How often do borrowers who buy houses with subprime loansget into trouble?
We estimate that between 13% and 18% of subprimepurchase experiences end in foreclosure.
Very sensitive to house prices
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 36 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
It’s the house prices
Our analysis shows that falling house prices are the driver offoreclosure activity.
Let me first present the evidence.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 37 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
2 4 6 8
9
10 12 1400
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0% < HPA ≤ 20% ց
ւ −20% < HPA ≤ 0%
ւ HPA ≤ −20%
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 38 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Figure: Foreclosures and house prices in Mass., 1989-present. Source:Boston Fed and The Warren Group.
-10
-5
5
0
0
0.2
0.4
0.6
0.8
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
10
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38
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osed
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ւ Foreclosure rate
%grow
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annual
rates
տ House price growth
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 39 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Figure: Foreclosures and 30-day delinquency rates in Mass.,1989-present. Source: Boston Fed, the MBA and The Warren Group.
00
0.20.2
0.40.4
0.60.6
0.80.8
2
2.2
2.4
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2.8
8888 8989 9090 9191 9292 9393 9494 9595 9696 9797 9898 9999 0000 0101 0202 0303 0404 0505 0606 0707
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YearYear
ւ Foreclosure rateւ Foreclosure rate
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Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 40 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
What we are saying?
Negative equity is necessary but not sufficient for foreclosures
In other words:
If equity is positive, almost no one defaults (because they cansell at a profit.If equity is negative, then default may make sense, but itdepends on other things.
Why should you hold on to a house when you have negativeequity?
You will eventually make moneyDepends on whether you can wait that longPatience, financial resources
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 41 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Defining a subprime mortgageResets aren’t the problemA profile of forecloseesSubprime outcomesIt’s the house prices
Figure: Cumulative appreciation for Massachusetts homeowner whobought in Q3, 1988.
-20
20
40
60
80
88 90 92 94 96 98
100
124
0
00 02 04 06 08
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 42 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
3. Housing wealth and consumption
Main difference with many others has to do with consumption.
How does a change in wealth affect consumption?
Some says $1 fall in housing wealth reduces spending by 5cents
We think it’s closer to 2 cents.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 43 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Figure: Consumption to wealth relationship over time, based on NIPAdata.
0.1
0.12
0.14
0.16
0.18
0.2
0.22
1.7 1.75 1.8 1.85 1.9 1.95 2 2.05 2.1
9.55
log(C
/Y)
log(W /Y )
տ Before 1/1/1996
↑ After 1/1/1996
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 44 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Figure: Consumption to housing wealth relationship over time, based onNIPA data.
0.1
0.12
0.14
0.16
0.18
0.2
0.22
0.24
0.26
0.4 0.5 0.6 0.7 0.8 0.9 1 1.1 1.2
9.55
log(C
/Y)
log(H/Y )
տ Before 1/1/1996
↑ After 1/1/1996
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 45 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
We attempted to put some numbers on it.
Essentially, we estimated that the wealth effect after 1996 isabout half what it was before.
A one-dollar increase in net worth
led to a 5.4 cent long-run increase in consumption before1/1/1996.led to a 2.2 cent long-run increase in consumption after1/1/1996.
A one-dollar increase in housing equity
led to a 10 cent increase in consumption before 1/1/1996.led to a 0 cent increase in consumption after 1/1/1996.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 46 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Financial Innovation and Credit Constraints
“Financial innovations” have made it easier to borrow againstyour house since the 1990s
No paperwork!No fees!
So doesn’t this mean that spending should be more sensitiveto house prices?
No, just the opposite.
Level of borrowing will go up.Sensitivity of borrowing goes down.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 47 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Increased house prices relax a borrowing constraint
Households have more debt...But the constraint matters to fewer consumers.
For most consumers, borrowing self-limited.
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 48 / 49
Introduction1. Credit Crunch
2. It’s the house prices3. Housing wealth and consumption
Conclusion
Two key things to worry about:
Can the Fed manage the liquidity squeeze?How much will house prices fall and how much will that affectconsumption?
Paul Willen (Boston Fed) The Subprime Crisis: December 6, 2007 49 / 49