Transcript U.S. Subprime Mortgage Market Meltdown

U.S. Subprime
Mortgage Market Meltdown
James R. Barth
Auburn University and Milken Institute
[email protected]
14th Dubrovnik Economic Conference
The Croatian National Bank
Dubrovnik, Croatia
June 25–28, 2008
“Any real-estate investment
is a good investment … ”
“Any real-estate investment
is a good investment … ”
… NOT!
Homeownership Rate Reaches
Historic High in 2004
Percent
69.2% in September 2004
70
69
68
67
66
67.8% in March 2008
65
64
63
62
1965
1969
Source: U.S. Census Bureau.
1973
1977
1981
1985
1989
1993
1997
2001
2005 2008
Home Prices Peak in 2006
Index, January 1987 = 100
600
California median
home price
500
400
300
S&P/Case-Shiller
home price index
200
100
OFHEO
conventional and
conforming home
price index
0
7 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
8
19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20
Sources: U.S. Office of Federal Housing Enterprise Oversight (OFEHO), Standard & Poor's,
California Association of Realtors, Moody's Economy.com.
Home Price Appreciation Peaks in 2005
House-price indices, % change on a year earlier
20
S&P/CaseShiller 10 city
S&P/CaseShiller national
15
10
OFHEO
5
0
-5
-10
-15
1988
1992
1996
2000
2004
2008
A Longer-Term Perspective on Home Prices
1890=100
220
220
Current
Boom
200
180
160
180
Great
Depression
World
War I
World
War II
200
1970’s 1980’s
Boom Boom
160
140
140
120
120
100
100
80
80
60
60
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: Robert J. Shiller, 2006.
History Repeats Itself:
Home Prices Don’t Just Go Up
Change in Home Prices in 100 plus years
Percentage change, year ago
40%
World
War I
Great
World
Depression War II
1970’s 1980’s
Boom Boom
Current
Boom
30%
20%
10%
0%
-10%
-20%
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: Robert J. Shiller, 2006.
Homes for Sale Take Off
Millions
Millions
4.8
0.8
4.2
0.7
3.6
0.6
3.0
Existing homes
(Left axis)
0.5
2.4
0.4
1.8
0.3
1.2
0.6
New homes
(Right axis)
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
20
08
0.0
Source: U.S. Census Bureau.
0.2
0.1
0.0
Single-family Home Sales
Reach New High Before Plunging
Millions, SAAR
Millions, SAAR
6.5
6.0
1.4
New homes
(Right axis)
1.2
5.5
1.0
5.0
0.8
4.5
4.0
Existing homes
(Left axis)
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: U.S. Census, National Association of Realtors, Moody’s Economy.com.
0.6
0.4
Existing Home Sales Are Down
Everywhere Over the Past Two Years
Percent change in existing home sales
Fourth-quarter 2005 through fourth-quarter 2007
Existing home sales nationwide down 29%
Source: Freddie Mac.
Median Existing Single-family Home Price:
Too Good to Last
Percent change, year ago
20
15
10
5
0
-5
-10
-15
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: National Association of Realtors, Moody’s Economy.com.
Forty-six States Had Falling
Prices in the Fourth Quarter 2007
United States: - 9.3% (fourth-quarter annualized growth)
Source: Freddie Mac.
Single-family Housing Starts
Percent change, year ago
40
20
0
-20
-40
-60
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: U.S. Census Bureau, Global Insight.
Single-family Building Hit a Record in 2005
But Was 53% Lower Two Years Later
Housing starts: Single-family privately owned
Thousands, SAAR
19
72
19
7
19 4
76
19
78
19
8
19 0
82
19
84
19
8
19 6
88
19
90
19
9
19 2
94
19
96
19
9
20 8
00
20
02
20
0
20 4
06
20
08
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
Source: U.S. Census Bureau.
Homes Sit Longer on the Market
Millions
Months
4.0
11
10
3.5
9
3.0
2.5
Homes available
for sale
(Left axis)
8
7
6
2.0
Months supply
(Right axis)
1.5
1.0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: National Association of Realtors, Moody’s Economy.com.
5
4
3
Home Prices and Credit Boom
Index, January 2000 = 100
250
200
US$ billions
4,500
Total
originations
(R)
4,000
3,500
S&P/CaseShiller®
home price
index (L)
150
100
3,000
2,500
2,000
Subprime
originations
(R)
50
1,500
1,000
500
07
20
06
20
05
20
04
20
03
20
02
20
01
20
00
20
99
19
98
19
97
19
96
19
19
19
95
0
94
0
Interest Rates: Too Low Too Long?
Fed Funds Rate vs. Rate on Long-term Government Bonds
Percent
7
6
Government bond rate
5
4
3
Fed funds rate
2
1
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: Federal Reserve, Global Insight.
Mortgage Rates: ARMs Appear Attractive to Many
Percent
9.0
8.0
30-yr fixed
7.0
6.0
5.0
4.0
1-yr ARM
3.0
2.0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: Mortgage Banker’s Association, Moody’s Economy.com.
ARM Share of Mortgages
Percent
40
35
30
Share of all
applications
25
20
15
Share of
all loans
10
5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: U.S. Federal Housing Finance Board, Freddie Mac, Moody’s Economy.com.
ARM Share of Mortgages
Percent of all loans
23
21.7
21
20.2
20.6
20.9
21.3 21.4 21.1
20.9
20.9 20.8
20.2
19.0
19
17.9
16.9
17
15.8
14.8
15
13
14.4
11.7 12.0 11.9
11
07
20
07
Q
4
20
07
Q
3
20
07
Q
2
20
06
Q
1
20
06
Q
4
20
06
Q
3
20
06
Q
2
20
05
Q
1
20
05
Q
4
20
05
Q
3
20
05
Q
2
20
04
Q
1
20
04
Q
4
20
04
Source: Mortgage Bankers Association.
Q
3
20
04
Q
2
20
03
Q
1
20
03
Q
4
20
03
20
Q
3
Q
2
Q
1
20
03
9
Source: Mortgage Bankers Association.
Q
4
Q
3
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
07
07
07
07
06
06
06
06
05
05
05
05
04
04
04
04
03
03
03
03
60
Q
2
Q
1
Q
4
Q
3
Q
2
Q
1
Q
4
Q
3
Q
2
Q
1
Q
4
Q
3
Q
2
Q
1
Q
4
Q
3
Q
2
Q
1
ARM Mortgage Share by Loan Type
Percent of loan type
70
FHA
Prime
Subprime
50
40
30
20
10
0
Prime and Subprime Home Mortgage Originations
Year
Total Originations
(US$ Trillions)
1994
Share of Total (%)
Prime
Originations
Subprime
Originations
0.77
95.5
4.5
1995
0.64
89.8
10.2
1996
0.79
87.7
12.3
1997
0.86
85.5
14.5
1998
1.45
89.7
10.3
1999
1.31
87.8
12.2
2000
1.05
86.8
13.2
2001
2.22
92.2
7.8
2002
2.89
92.6
7.4
2003
3.95
91.6
8.4
2004
2.92
81.8
18.2
2005
3.12
78.7
21.3
2006
2.98
79.9
20.1
2007
2.43
92.1
7.9
2008 Q1
0.48
97.9
2.1
Source: Inside Mortgage Finance.
Mortgage Originations by Product
Subprime and Alt A shares quadruple
between 2001 and 2006, then fall in 2007.
4.6%
2.6%
14.4%
14.4%
8.0%
2.7%
33.2%
8.4%
13.4%
4.9%
47.3%
11.3%
56.9%
7.9%
19.4%
20.1%
2001
$2.2 trillion
16.1%
2006
$3.0 trillion
Conventional, conforming prime
Source: Inside Mortgage Finance.
14.3%
2007
$2.4 trillion
Jumbo prime
Subprime
Alt-A
FHA & VA
Home equity loans
2/28 ARMs Dominate Subprime
Home-purchase Loan Originations in 2006
Other
ARM
7%
Other
ARM
OtherARM
Fixed
9%
4%
30Yr ARM
Balloon W/
40-50-Yr
Amtz 26%
2-year
& 3-year
hybrids
61%
Subprime
Source: Freddie Mac.
Other
ARM
23%
Fixed
31%
Alt-A
ARM
hybrids
46%
ARM
Hybrids
23%
Fixed
70%
Prime
conventional
Subprime Mortgage Loans Outstanding
US$ billions
1,400
1,200 1,240
1,200
973
1,000
895
800
600
400 290 283
940
574
699
479
416
319 344 382
200
0
5 96 97 98 99 00 01 02 03 04 05 06 07
9
1Q
9
9
9
9
9
0
0
0
0
0
0
0
0
1
1
1
1
1
2
2
2
2
2
2
2
2 08
20
Source: Inside Mortgage Finance.
Distribution of Prime and Subprime Residential
Mortgage Originations by FICO Score
(2006)
Percent of Total Originations
16%
Subprime
Prime
14%
12%
10%
8%
6%
4%
2%
0
46 459
0
48 479
0
50 499
0
52 519
0
54 539
0
56 559
0
58 579
0
-5
60 99
0
62 619
0
64 639
0
66 659
0
68 679
0
-6
70 99
0
-7
72 19
0
74 739
0
76 759
0
78 779
0
80 799
0
-9
00
0%
FICO Score
National Distribution of FICO Scores
Percentage of Population
30
27
25
20
18
15
15
12
10
13
8
5
5
2
0
up to
499
500-549 550-599 600-649 650-699 700-479 750-799
800
Origin of “Securitization”
“But I don’t know any other word to describe
what we are doing. You will have to use it
(securitization).”
Lewis Ranieri
“The Origins of Securitization, Sources of Its Growth,
and Its Future Potential,” A Primer on Securitization
Surge in Amount and Diversity of
U.S. Asset-backed Securities Outstanding
US$ trillions
10.0
9.0
Other
Student Loans
8.0
Home Equity
7.0
6.0
Credit Card
5.0
Automobile
4.0
3.0
Non-agency
MBS
Agency CMO
2.0
1.0
Agency MBS
0.0
1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Securities Industry and Financial Markets Association.
U.S. Asset-backed Securities Outstanding
1999, Total = US$4,235 Billions
Student Loans
1%
Home Equity
Other
3%
8%
Student Loans
3%
Other
11%
Home Equity
6%
Credit Card
6%
Credit Card
4%
Automobile
3%
Non-agency
MBS
9%
2007, Total = US$9,682 Billions
Agency MBS
54%
Agency CMO
16%
Source: Securities Industry and Financial Markets Association.
Agency MBS
46%
Automobile
2%
Non-agency
MBS
14%
Agency CMO
14%
Home Mortgage Security Issuance
1985, Total = $110 Billion
2006, Total = $2.1 Trillion
NonAgency
2%
GNMA
4%
FNMA
21%
FHLMC
18%
GNMA
42%
NonAgency
56%
FHLMC
35%
2007, Total = $1.9 Trillion
GNMA
5%
NonAgency
38%
FHLMC
24%
FNMA
22%
FNMA
33%
Outstanding Home Mortgage Securities
1986, Total = $548 Billion
NonAgency
MBS
Fannie
3%
Mae MBS
18%
Freddie
Mac PCs
31%
2006, Total = $5.7 Trillion
NonAgency
MBS
32%
Ginnie
Mae MBS
48%
Ginnie
Mae MBS
7%
Fannie
Mae MBS
35%
2007, Total = $6.6 Trillion
NonAgency
Freddie MBS
32%
Mac PCs
26%
Ginnie
Mae MBS
7%
Freddie
Mac PCs
26%
Fannie
Mae MBS
35%
Private-label Mortgage-backed
Security Issuance Has Fallen Sharply
Subprime & other
Dollar amount of Issuance, US$ billions
200
52
Alt-A
30
Prime Jumbo
37
Freddie Mac &
Fannie Mae
150
20
16
8
14
7
94
99
97
34
100
50
19
85
101
0
March 2007 June 2007
Sep. 2007 Dec. 2007
April 2008
$191 Billion $181 Billion $137 Billion $109 Billion $102 Billion
Source: Inside Mortgage Finance.
Origination Shares of Mortgage Brokers
Account for Majority of Home Mortgage Originations
1987
Number of mortgage brokers:
7,000
Brokers
2006
Number of mortgage brokers:
53,000
20%
Others
42%
80%
Others
Source: Wholesale Access.
Brokers
58%
Monoline Insurers’ Financial Guarantees of Securities
Increase, But What Happens If They Cannot Be
Honored?
Net Par Outstanding = $3.5 Trillion
December 2006
Public Finance,
$1.3 Trillion,
38%
Structured
Finance,
$2.2 Trillion,
62%
Mortgage-Backed
Securities: U.S.
19%
15%
45%
11%
19%
34%
6%
Other AssetBacked Securities:
U.S.
Mortgage-Backed
Securities:
International
Other AssetBacked Securities:
International
Other
15%
28%
8%
General
Obligation
Utility
Revenue
Tax-Backed
Revenue
Transportation
Revenue
Other
Securitization: Originate to Distribute vs.
Originate to Hold
100%
Other
Non-Agency
Issuers
80%
Government-Sponsored
Enterprises and Agencies
60%
Saving Institutions
40%
20%
Commercial Banks
0%
1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
Subprime Crisis Overview
December 2006–March 2008
S&P 500 Index
1,600
Apr. 07: New Century,
a mortgage broker,
files for bankruptcy
1,550
1,500
Aug. 07: Fed cuts
discount rate to
5.75%
Oct. 07: Merrill announces
$7.9b in subprime writedowns, surpassing Citi’s
$6.5 billion
Mar. 11, 08: Fed offers
troubled banks as
much as $200 billion
Dec. 06: Ownit
Mortgage, a subprime
lender, files for
bankruptcy
Mar. 16, 08: JP
Morgan offers
to buy Bear
Stearns
1,450
1,400
1,350
Feb. 07: HSBC says it
set aside $10.6 billion
for bad loans, incl.
subprime
Jul. 07: Two Bear
Stearns hedge funds
file for bankruptcy
Jan. 11, 08: BofA agrees
to buy Countrywide
Jan. 30, 08: Fed
cuts discount
rate to 3.5%
1,300
1,250
Mar. 18, 08: Fed cuts
discount rate to 2.4%; Fed
funds rate to 2.25%
2006 Q4
2007 Q1
2007 Q2
2007 Q3
Sources: BusinessWeek (March 31, 2008), Standard & Poor’s and Global Insight.
2007 Q4
2008 Q1
Ratio of Median Home Price
to Median Household Income Surges
Median Home Price/Median Household Income
5.0
4.5
4.0
3.5
3.0
2.5
'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06
Home Mortgage Share of Household
Liabilities Reaches a New High in 2007
Percent
75
70
65
60
55
1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007
Source: Federal Reserve.
Leverage of U.S. Households has
Increased Rapidly Since 1980
Home mortgage debts as % of disposable personal income
Percent
75
70
65
60
55
1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008
Sources: Federal Reserve and Moody’s.
Sixty-day plus Home
Mortgage Delinquency Rates Are on the Rise
25%
20%
Subprime
15%
10%
Alt-A
Alt A
5%
Jumbo prime
Ja
n00
Ju
l-0
Ja 0
n01
Ju
l-0
Ja 1
n02
Ju
l-0
Ja 2
n03
Ju
l-0
Ja 3
n04
Ju
l-0
Ja 4
n05
Ju
l-0
Ja 5
n06
Ju
l-0
Ja 6
n07
Ju
l-0
7
0%
Sources: First American Corelogic and LoanPerformance databases.
Subprime ARM Defaults Are 12 Times Those for
Prime
Delinquent or In Foreclosure (Percent of Number)
30
Subprime ARM,
26.09
25
20
15
10
Subprime FRM, 9.82
5
FHA & VA, 5.96
Prime, 2.08
Q
2
1
Q 998
4
19
Q 98
2
1
Q 999
4
1
Q 999
2
20
Q 00
4
2
Q 000
2
20
Q 01
4
2
Q 001
2
20
Q 02
4
2
Q 002
2
20
Q 03
4
2
Q 003
2
20
Q 04
4
2
Q 004
2
20
Q 05
4
2
Q 005
2
2
Q 006
4
20
Q 06
2
2
Q 007
4
20
07
0
Subprime Loans Accounted for
Over Half of Foreclosures Since 2006
Number of foreclosures started (Annualized rate in thousands)
1,800
Subprime: 13% of
Subprime
loans serviced
1,500
(December)
FHA and VA
1,200
Prime (includes Alt-A)
900
56%
9%
55%
600
300
54%
37%
36%
37%
29%
29%
29%
44%
47%
52%
22%
20%
31%
2006
H1
34%
35%
34%
34%
33%
2003
H2
2004
H1
2004
H2
2005
H1
2005
H2
17%
13%
32%
11%
33%
37%
0
Source: Mortgage Bankers Association National Delinquency Survey
(data as of December 2007, number expanded to reflect 85% coverage).
2006
H2
2007
H1
2007
H2
Percent Change in Delinquency Rate
of Subprime ARM Loans
Between 2005Q2 and 2007Q2
Less than 60%
60%-110%
110%-180%
More than 180%
Sources: Mortgage Bankers Association, Milken Institute.
National Subprime Foreclosure Rates
by Origination Year*
Foreclosure Rates in
Origination Year and
Subsequent Years
Origination Year
Year to
July 2007
1999
2000
2001
2002
2003
2004
2005
2006
1.30
6.33
5.46
4.85
2.29
2.05
0.79
0.56
0.24
1.50
6.86
6.01
3.35
2.49
1.19
0.71
0.30
1.85
7.17
5.81
4.23
1.88
1.17
0.48
1.07
5.51
4.55
2.37
1.56
0.59
0.82
4.14
3.11
2.23
0.83
0.86
3.93
3.66
1.85
0.97
6.38
4.66
2.56
7.69
3.01
188,026
165,801
140,195
124,781
127,100
176,729
231,360
140,278
13,272
Total Number of
Originations
787,420
739,749
620,945
797,625
1,143,037
1,716,141
1,925,780
1,368,706
440,934
Foreclosure Rate through
September 2007
23.88
22.41
22.58
15.64
11.12
10.30
12.01
10.25
3.01
Foreclosure Year
Originate year
1st year
2nd year
3rd year
4th year
5th year
6th year
7th year
8th year
Total Number of
Foreclosures From
Origination through
September 2007
*Foreclosure rates are based on the number of loans starting foreclosure.
California Subprime Foreclosure Rates
by Origination Year*
Foreclosure Rates in
Origination Year and
Subsequent Years
Origination Year
Year to
July 2007
1999
2000
2001
2002
2003
2004
2005
2006
0.88
4.03
3.01
2.66
0.93
0.46
0.12
0.06
0.03
0.76
3.72
2.99
1.26
0.49
0.11
0.07
0.02
1.01
4.29
2.74
1.17
0.22
0.12
0.04
0.70
3.18
1.68
0.36
0.16
0.06
0.48
2.08
0.79
0.34
0.12
0.50
2.04
1.46
0.85
0.76
5.97
5.51
5.20
14.10
4.88
9,160
8,389
9,528
9,137
8,944
16,161
39,198
31,295
2,973
Total Number of
Originations
75,224
88,915
99,412
148,796
235,065
333,327
320,200
162,134
60,871
Foreclosure Rate through
September 2007
12.18
9.43
9.58
6.14
3.80
4.85
12.24
19.30
4.88
Foreclosure Year
Originate year
1st year
2nd year
3rd year
4th year
5th year
6th year
7th year
8th year
Total Number of
Foreclosures From
Origination through
September 2007
*Foreclosure rates are based on the number of loans starting foreclosure.
Determinants of Delinquency and
Foreclosure Rates in CBSAs
January 1999–December 2006
Variables
C
ARM
FICO < 620
LTV > 80
LOWNODOC
Interaction of All Four Loan
Characteristics
Population
Median Family Income Growth
Home Price Growth
Unemployment
Average Loan Size
60+ Days Delinquent
and In Foreclosure
-16.868*** -8.036***
21.771*** 22.567***
9.757***
1.563*
53.410*** 33.103***
17.031*** 20.549***
90+ Days Delinquent
and In Foreclosure
In Foreclosure
-7.780*** -3.035*** -10.365*** -6.498***
11.523*** 12.191*** 10.089*** 10.202***
3.266***
-1.068**
7.767***
4.017***
27.963*** 17.067*** 24.812*** 15.692***
7.628*** 10.058*** 9.867*** 11.075***
201.692*** 164.110*** 118.785*** 89.430***
1.688***
-2.048***
-25.700***
1.340***
-0.049***
0.823**
-0.768**
-13.091***
0.719***
-0.028***
73.308***
62.224***
0.949***
-1.719***
-11.435***
0.613***
-0.021***
0.6466
0.7043
0.6200
0.6768
0.6395
0.6962
Adjusted R-square
34224
34224
34224
34224
34224
34224
Number of Observations
360
360
360
360
360
360
Number of CBSAs
Note: ***, **, and * denote significance at 1, 5, and 10 percent levels, respectively. CBSA denotes corebased statistical area. Includes CBSA fixed effects.
Determinants of Delinquency and
Foreclosure Rates in CBSAs
January 1999–December 2005
Variables
C
ARM
FICO < 620
LTV > 80
LOWNODOC
Interaction of All Four Loan
Characteristics
Population
Median Family Income Growth
Home Price Growth
Unemployment
Average Loan Size
60+ Days Delinquent
and In Foreclosure
-20.594*** -14.972***
23.762*** 24.692***
10.678*** 5.818***
60.163*** 41.033***
12.880*** 20.157***
90+ Days Delinquent
and In Foreclosure
In Foreclosure
-10.032*** -7.082*** -11.168*** -8.664***
12.482*** 13.304*** 11.056*** 11.228***
4.407***
1.788***
6.731***
4.553***
31.243*** 20.929*** 27.730*** 19.273***
6.113*** 10.506*** 7.556*** 10.328***
307.380*** 187.290*** 166.440*** 92.650*** 128.897*** 84.331***
2.161***
-2.213***
-18.750***
1.480***
-0.057***
1.351***
-1.101***
-9.630***
0.796***
-0.033***
0.964***
-1.320***
-8.970***
0.650***
-0.023***
0.6396
0.6927
0.6085
0.6626
0.6355
0.6852
Adjusted R-square
30036
30036
30036
30036
30036
30036
Number of Observations
360
360
360
360
360
360
Number of CBSAs
Note: ***, **, and * denote significance at 1, 5, and 10 percent levels, respectively. CBSA denotes core-based
statistical area. Includes CBSA fixed effects.
Determinants of Delinquency and
Foreclosure Rates in CBSAs
January 1999–December 2004
Variables
C
ARM
FICO < 620
LTV > 80
LOWNODOC
Interaction of All Four Loan
Characteristics
Population
Median Family Income Growth
Home Price Growth
Unemployment
Average Loan Size
60+ Days Delinquent
and In Foreclosure
-16.427*** -15.111***
26.290*** 27.469***
1.228
0.125
61.173*** 48.908***
3.752***
9.777***
90+ Days Delinquent
and In Foreclosure
In Foreclosure
-7.510*** -6.824*** -9.204*** -8.671***
13.680*** 14.619*** 12.423*** 12.364***
-0.868
-1.482**
2.051***
1.617***
31.379*** 24.678*** 28.574*** 23.128***
1.451*
5.173***
2.487***
4.438***
521.907*** 351.432*** 280.018*** 178.666*** 237.738*** 174.602***
2.254**
-2.403***
-13.716***
1.478***
-0.061***
1.346***
-1.251***
-6.812***
0.799***
-0.035***
0.877**
-1.402***
-6.535***
0.684***
-0.025***
0.6329
0.6746
0.5987
0.6417
0.6328
0.6730
Adjusted R-square
25848
25848
25848
25848
25848
25848
Number of Observations
360
360
360
360
360
360
Number of CBSAs
Note: ***, **, and * denote significance at 1, 5, and 10 percent levels, respectively. CBSA denotes core-based
statistical area. Includes CBSA fixed effects.
The Mortgage Problem in Perspective
80 million houses
25 million are paid off
55 million have mortgages
51 million are paying on-time
4 million are behind
(8% of 55 million with 2% in foreclosure)
This compares to 50% seriously delinquent in the 1930s
Source: U.S. Treasury Department.
“A billion here, a billion there, and
pretty soon you’re talking real
money.”
-- U.S. Senator Everett Dirksen, 1961
“A billion^here, a billion^there,
and pretty soon you’re talking real
money.”
-- U.S. Senator Everett Dirksen,
1961
Estimates of Losses From Subprime Crisis
Date
Estimate
Source
7/19/2007
$50-100 billion
Bernanke testimony before congress
10/17/2007
$100-200 billion
William C. Dudley, NY Fed
11/8/2007
$150 billion
Bernanke testimony before Congress
11/15/2007
$400 billion
Deutsche Bank
11/16/2007
$400 billion
Goldman Sachs
12/19/2007
$200-300 billion
The Economist
1/31/2008
$120 billion
Wall Street Journal
2/11/2008
$400 billion
German finance minister at G7 meeting
3/3/2008
$170 billion
3/3/2008
$600 billion
3/10/2008
$215 billion
Wikipedia
Geraud Charpin, head of European
credit strategy at UBS in London
Head of Japan's financial regulator
3/13/2008
$285 billion
Standard and Poor’s
Supbrime’s Biggest Losers
Losses/write-downs through May 27, 2008, US$ billions
Citigroup
UBS
Merrill Lynch
HSBC
IKB Deutsche
Royal Bank of Scotland
Bank of America
Morgan Stanley
JPMorgan Chase
Credit Suisse
Washington Mutual
Credit Agricole
Deutsche Bank
Wachovia
Source: Bloomberg.
42.9
38.2
37.0
19.5
16.1
15.4
14.8
12.6
9.8
9.7
9.1 The collapse of credit markets in
the United States, driven by the
8.4
subprime loan crisis, has led to
7.7
major losses for banks
7.0
worldwide.
Recent Losses/Write-downs and
Capital Raised by Financial Institutions
2Q 2008
(through May 27)
Total
Citigroup, United States
UBS, Switzerland
Merrill Lynch, United States
HSBC, United Kingdom
IKB Deutsche, Germany
Royal Bank of Scotland, United Kingdom
Bank of America, United States
Morgan Stanley, United States
JPMorgan Stanley, United States
Credit Suisse, Switzerland
World total (US$ billions)
Source: Bloomberg.
Loss
/Writedown
Capital
Raised
Loss
/Writedown
Capital
Raised
42.9
38.2
37.0
19.5
16.1
15.4
14.8
12.6
9.8
9.7
382.8
44.1
28.8
17.9
2.0
13.3
23.8
19.7
5.6
708.0
1.5
269.9
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.9
12.9
16.2
4.3
2.0
0.0
23.8
6.7
0.0
7.8
0.0
139.0
Financial Stocks Take Big Hits in Subprime Crisis
Percentage change in price, December 2006–March 2008
-94%
-87%
Bear Stearns
Countrywide
Washington Mutual
Freddie Mac
Merrill Lynch
Fannie Mae
Wachovia
UBS
Lehman Brothers
AIG
Morgan Stanley
Bank of America
Wells Fargo
Goldman Sachs
JP Morgan & Chase
-77%
-63%
-56%
-56%
-53%
-52%
-52%
-40%
-32%
-29%
-18%
-17%
-11%
-1
Source: Bloomberg.
-0.8
-0.6
-0.4
-0.2
0
Leverage Ratios of Different Types of Financial Firms
2007
Government-sponsored enterprises
24.7
Brokers and hedge funds
31.6
Credit unions
8.4
Savings institutions
8.4
Commerical banks
9.8
0
Source: David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin, 2008
5
10
15
20
25
Asset/Capital
30
35
Too Much Dependence on Debt?
Leverage Ratios At Biggest Investment Banks
Total assets to total shareholder equity
40
March 2008
35
March 2001
30
25
20
15
Bear
Stearns
Morgan
Stanley
Note: * the latest figure is as of December 2007
Sources: Bloomberg.
Merrill
Lynch
Lehman
Bros.*
Goldman
Sachs
Banks Depend Less on Debt
Leverage Ratios At Bank Holding Companies
Total assets to total shareholder equity
21
March 2001
December 2007
17
March 2008
13
9
5
Citigroup
Sources: Bloomberg.
JP Morgan Chase
Bank of America
What Broke the Cycle?
Fraud: by borrowers, brokers, appraisers, lenders.
Cracks in most overheated markets (LA, Las Vegas, Miami) quickly
spread everywhere.
Most highly leveraged vehicles (CLOs) collapsed first
 Followed by second most leveraged institutions – banks (not hedge
funds).
Difference this time: Primary losers are those who own AAA debt.



Downgrades in the Asset-Backed
Securities Markets
7,000
AAA Downgrades
In the Asset-Backed Securities Markets
6,566
160
134

140
6,000
120
5,000
92
100
85
78
4,000
80
3,000
1,635
1,215
8
5
0
0
0
0
0
0
6
6
7
9
20
0
1
0
0
0
15
23
40
210
415
0
1
15
0
13
12
30
12
3
1
0
4
140
80
171
122
539
2,000
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
0
Source: Moody’s
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
1,000
60
Source: Moody’s
Most New Securities Were Rated AAA
by S&P in 2007
Number
1,400
1,200
1,295 or 45% of new securities rated
1,000
by S&P were rated AAA in 2007
800
600
400
C
CCC
BB
B
BB+
BB-
CCC
B+
B-
A1+
B
AA+
BBB
A-
BBB
AA-
A+
A
AA
AAA
200
When is a AAA not a AAA?
Multilayered structured credit products
High-grade structured-finance CDO
Mortgage loans
Mortgage bonds
AAA
AA
A
BBB
BB-unrated
80%
11%
4%
3%
2%
Source: International Monetary Fund.
Senior AAA
Junior AAA
AA
A
BBB
Unrated
88%
5%
3%
2%
1%
1%
Mezzanine structuredfinance CDO
Senior AAA
62%
Junior AAA
14%
AA
8%
A
6%
BBB
6%
Unrated
4%
CDO-Squared
Senior
AAA
Junior
AAA
AA
A
BBB
Unrated
60%
27%
4%
3%
3%
2%
Most Texas Banks Were AAA
in the 1980s
First RepublicBank Corporation
Foreclosures in Houston
30,000
20,000
10,000
1,000
1980
Source: Harris County Foreclosure Listing Service.
1986
1992
Widening Spreads
Mortgage-backed and High-yield Bonds
Basis point spread above 10-year treasury bond
1200
ML BBB Mortgage-Backed Securities Index
1000
800
ML High-Yield Bond Index
600
400
200
0
Jan-06 Apr-06
Source: Bloomberg.
Jul-06
Oct-06
Jan-07 Apr-07
Jul-07
Oct-07 Jan-08
Widening Spreads
Municipal Bonds
Basis point spread over 10-year treasury bond
120
ML municipal master
index yield spread
80
40
0
-40
-80
Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08
Source: Bloomberg.
Market for Liquidity Freezes
Thirty-Day AA Rated Commercial Paper Rates
Percent
6.5
Asset-backed
Commercial
Paper
6.0
5.5
5.0
4.5
4.0
Nonfinancial
Commercial
Paper
3.5
Financial
Commercial
Paper
3.0
2.5
2.0
1.5
May
07
Jun
07
Source: Federal Reserve.
Jul
07
Aug
07
Sep
07
Oct
07
Nov
07
Dec
07
Jan
08
Feb
08
Mar
08
Apr
08
May
08
Mortgage Loan Fraud Surges
Thousands
60
50
40
30
20
10
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Source: Financial Crimes Enforcement Network.
Dollar Losses in Reported Cases of Mortgage Fraud
US$ Millions
1,200
1,014
1,000
946
813
800
600
429
400
293
225
200
0
2002
2003
Source: Federal Bureau of Investigation.
2004
2005
2006
2007
Tightened Standards For Real Estate Loans
Net percentage of domestic respondents tightening
standards for commercial real estate loans
Percent
100
Subprime
The end of S&L crisis
80
LTCM
Dotcom
60
40
20
0
-20
-40
Mar-90
Source: Federal Reserve.
Mar-93
Mar-96
Mar-99
Mar-02
Mar-05
Mar-08
Despite Federal Funds Rate Cuts,
Mortgage Rates Remain Relatively Flat
4.0
3.5
8.0
Freddie Mac 30-year fixed mortgage rate
7.0
3.0
6.0
2.5
5.0
2.0
Federal funds rate
4.0
1.5
3.0
1.0
Spread
2.0
0.5
1.0
0.0
0.0
January 2007
Sources: Federal Reserve, Freddie Mac.
June 2007
November 2007
April 2008
Is Adequate Information Disclosed to Consumers?
Percentage of people in a study who could not correctly identify
various loan terms using current mortgage disclosure forms
Annual percentage rate: 20
Monthly payment: 21
Loan amount: 51
Existence of prepayment
penalty: 68
Total upfront
Cost: 87
0
20
Source: Los Angeles Times, June 14, 2007.
40
60
80
100
Percent
Looking For a Bottom
Economists say the economy isn’t at its low point yet,
and house prices likely won’t get there until 2009
Does this feel like the bottom
of a downturn?
When will home prices hit bottom?
1st half
2010
Yes: 27%
No: 73%
6%
2nd half
2009
29%
1st half
2009
38%
2nd half
2008
1st half
2008
Source: The Wall Street Journal, April 11, 2008.
17%
4%
How Far Do Home Prices Have to Fall?
Annual rents as % of house prices
6.50
6.00
5.50
5.00
4.50
4.00
3.50
19
60
19 Q
62 1
19 Q
65 3
19 Q
67 1
19 Q
70 3
19 Q
72 1
19 Q
75 3
19 Q
77 1
19 Q
80 3
19 Q
82 1
19 Q
85 3
19 Q
87 1
19 Q
90 3
19 Q
92 1
19 Q
95 3
19 Q
97 1
20 Q
00 3
20 Q
02 1
20 Q
05 3
20 Q
07 1
20 Q
10 3
Q
1
3.00
Source: :”The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing,” December 2007.
History of Credit Disruptions:
1998–Today
Recent credit disruption was preceded by 5 years of benign credit market
Nov - Aug
1998
Russian
Key Causes
Investment
Grade Spread
Widening
credit
default
Long Term
Capital
70+
bps
4Q 2001 - 2002
credit
fundamentals
Major corporate
defaults and
accounting scandals
(Enron, WorldCom)
Jul 2007- Present
Weak

80+ bps
Deteriorating
housing/subprime
market
Market de-leveraging
1200+
bps
Tremendous
Significant
Key Issues
counterpart
y risk
Corporate
and fraud
scandals
supply/demand
imbalance
Recapitalization of
financial institutions
What Went Wrong:
1960s
1980s
Today
2020s?
Enough Blame to Go Around

Nonresident speculators

Regulators/central bankers

Brokers/other intermediaries

Rating agencies

Institutional investors

Home buyers

Appraisers
$1 Trillion Losses

The “Nifty Fifty” stocks - early 1970s

Sovereign debt: 1980s

Texas banks/Southwest real estate: 1980s

Japanese real estate/equities: 1980s-90s

Technology: 2000

Housing-related investments: 2007-8
Credit Issues

Ratings consistency  Business volatility

Real estate price
fluctuation

Liquidity risk

Counterparty risk
Interest rate
volatility

Currency risk

Unexpected regulatory
requirements

Complexity



Sovereign debt risk
Leverage
1974:
The most important year
in financial history
since World War II.
1974:

Interest rates double in one year;
highest level in recent recorded U.S.
history

Regulation restricts lending

Energy prices skyrocket

U.S. stock market plunges 50%
1974:
RESULT
Companies with the highest returns on
capital, fastest rates of market share
and employment growth, greatest
contributions to technological and
new- product innovation were denied
access to equity and debt capital.
For 1975 through 1976, the return on
investment non-investment debt-grade
portfolios to investors was 100%
unleveraged.
Fewer than 1 percent of those companies
projected to be candidates for
bankruptcies actually defaulted.
“I’ll Never Own a Stock Again”
Dow Jones Industrial Average
Index
1,100
1052 on 11 Jan. 1973
1,000
900
800
700
600
500
578 on 6 Dec. 1974
1973
1974
1975
1976
“I’ll Never Own a Stock Again”
Dow Jones Industrial Average
Index
1,100
1052 on 11 Jan. 1973
1,000
900
800
700
600
500
578 on 6 Dec. 1974
1973
1974
1975
1976
The $55 Billion Misunderstanding
Investing in the Nifty Fifty
12/31/72 – 12/31/81
90% of the “Nifty Fifty” showed a negative
return over nine years. The average
inflation-adjusted rate of return was -46%.
The $55 Billion Misunderstanding
Investing in the Nifty Fifty
12/31/72 – 12/31/81
The average P/E ratio of these 16
companies dropped from 66 to 11.
Avon
ADP
Coke
Disney
Kodak
H-P
J&J
Eli Lilly
Marriott
McDonald’s
Merck
Polaroid
Rite-Aid
Wal-Mart
Xerox
Dr. Pepper
Imperial Palace
(Tokyo)
1990
US$5.1 trillion
Residential Property
(California)
1990
US$2.4 trillion
Imperial Palace
(Tokyo)
2006
US$1.7 trillion
Residential Property
(California)
2006
US$6.5 trillion
“Real estate prices
collapsed, credit
dried up, house
building stopped ...
“Real estate prices
collapsed, credit
dried up, house
building stopped ...
in 1792.”