making sense of the mortgage meltdown
DESCRIPTION
Great slide deck untangling the mortgage meltdown from a seminar today at the Milken Institute in Los Angeles.TRANSCRIPT
11
Demystifying the Mortgage Meltdown:What It Means for Main Street,
Wall Street and the U.S. Financial System
Milken InstituteOctober 2, 2008
Glenn Yago Director of Capital Studies
James R. Barth Senior Fellow
22
“I have great, great confidence in our capital markets and in our financial institutions. Our financial institutions, banks and investment banks are strong.”
Treasury Secretary Henry PaulsonMarch 16, 2008
CNN
33
… but just six months later…
“The financial security of all Americans … depends on our ability to restore our financial institutions to a sound footing.”
Treasury Secretary Henry PaulsonSeptember 19, 2008
Press release
44
“Any real estate investment is a good investment … ”
55
… Really?!
“Any real estate investment is a good investment … ”
66
Subprime mortgage meltdown timelineDecember 2006–September 2008
Sources: BusinessWeek, S&P, Global Insight, Milken Institute.
250
350
450
550
650
Dow Jones U.S. Financial Index
Dec. 2006: Ownit Mortgage, a subprime lender, files for bankruptcy.
Apr. 2007: New Century, a mortgage broker, files for bankruptcy.
Feb. 2007: HSBC sets aside $10.6 billion for bad loans, including subprime.
July 31, 2007: Two Bear Stearns hedge funds file for bankruptcy.
Aug. 17, 2007: Fed cuts discount rate to 5.75%; Fed introduces Term Discount Window Program.
Jan. 11, 2008: Bank of America agrees to buy Countrywide.
Jan. 30, 2008: Fed cuts discount rate to 3.5%.
Mar. 18, 2008: Fed cuts discount rate to 2.4%; Fed funds rate to 2.25%.
Mar. 11, 2008: Fed offers troubled banks as much as $200 billion in loans; Fed introduces Term Securities Lending Facility.
Mar. 16, 2008: JP Morgan Chase offers to buy Bear Stearns; Fed introduces Primary Dealer Credit Facility.
Oct. 24, 2007: Merrill announces $7.9 billion in subprime write-downs, surpassing Citi’s $6.5 billion.
June 9, 2008:Lehman announces a $2.8 billion loss.
July 11, 2008: IndyMacis seized by FDIC.
Dec. 12, 2007: Fed introduces Term Auction Facility.
Feb. 13, 2008: President Bush introduces tax rebate stimulus program of $168 billion.
Aug. 1, 2008: First Priority Bank closes.
Feburary–March 2007: More than 25 subprime lenders declare bankruptcy.
Aug. 6, 2007: American Home Mortgage files for bankruptcy.
Sept. 30, 2007: NetBank goes bankrupt.
Aug. 16, 2007: Countrywide gets emergency loan of $11 billion from a group of banks.
July 30, 2008: President Bush signs a housing rescue law.
Sept. 7, 2008: U.S. seizes Fannie Mae and Freddie Mac.
Sept. 14, 2008: Lehman files for bankruptcy.
Sept. 16, 2008: Fed loans AIG
$85 billion.
Sept. 23, 2008: Washington Mutual is seized by FDIC.
Sept. 29, 2008: Citigroup agrees to buy Wachovia bank.
77
Overview
88
Home mortgages: Who borrows, how much has been borrowed, and who funds them?
Note: total residential and commercial mortgages = $14.7 trillion; 5 percent = $700 billion
Government-controlled
46%
Privatesector-
controlled54%
Total value of housing stock = $19.3 trillion
Equity in housing stock$8.7 trillion
Mortgage debt $10.6 trillion
Prime 91.6%
Subprime8.4% Securitized
58%
Non-securitized42%
Sources: Federal Reserve, Milken Institute.
99
The mortgage problem in perspective
80 million houses27 million are paid off
53 million have mortgages 48 million are paying on time
5 million are behind
This compares to 50% seriously delinquent in the 1930s.
(9.2% of 53 million with 2.8% in foreclosure)
Sources: U.S. Treasury, Milken Institute.
1010
I. Low interest rates and a lending boom
1111
Did the Fed lower interest rates too much and for too long?Federal funds rate vs. rates on FRMs and ARMs
0
1
2
3
4
5
6
7
8
2001 2002 2003 2004 2005 2006 2007 2008
Percent
Record low from June 25, 2003, to June 30, 2004: 1%
30-year FRM rate
1-year ARM rate
Target federal funds rate
Sources: Federal Reserve, Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
1212
Home price bubble and credit boom
Low interest rates and credit boom
Index, January 2000 = 100
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2001 2003 2005 20070
50
100
150
200
250US$ trillions
Home mortgage
originations (left axis)
S&P/Case-Shiller National Home
Price Index (right axis)
Sources: Inside Mortgage Finance, Mortgage Bankers Association, Moody’s Economy.com, S&P/Case-Shiller, Milken Institute.
US$ trillions
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2001 2003 2005 20073.0
3.5
4.0
4.5
5.0
5.5
6.0
1-Year ARM rate (right axis)
Home mortgage
originations (left axis)
Percent
1313
II. Homeownership, prices, starts and sales take off
1414
64
65
66
67
68
69
70
1998 2000 2002 2004 2006 2008
Percent
Q2 2004: 69.2%Q2 2008: 68.1%
Average, 1965–Q2 2008: 65.2%0
100
200
300
400
500
600
700
1998 2000 2002 2004 2006 2008
US$ thousands
California m edian hom e price
U.S. m edianhom e price
U.S. average, 1987-2008: $121,280
California average1987-2008$229,748
Credit boom pushes homeownership rate
to historic high
Home price bubblepeaks in 2006
California and national home prices reach
record highs
80
130
180
230
280
330
380
1998 2000 2002 2004 2006 2008
Index, January 1987 = 100S&P/
Case-Shille r National Hom e
Price Index
OFHEO Hom e Price Index
Sources: U.S. Census Bureau, OFHEO, Moody’s Economy.com, S&P/Case-Shiller, California Association of Realtors, Milken Institute.
1515
0.0
1.4
2.8
4.2
5.6
7.0
1998 2000 2002 2004 2006 20080.0
0.3
0.6
0.9
1.2
1.5Millions Millions
New hom e sales (r ight axis)
Existing hom e sales (le ft axis)
0.0
0.5
1.0
1.5
2.0
1998 2000 2002 2004 2006 2008
January 2006: 1.8 m illion
July 2008: 641,000
Housing units, millions
Average starts , 1959–July 2008: 1.1 m illion
Homes for sale Homes sales reach a new high
Housing starts hit a record in 2005
Sources: U.S. Census Bureau, OFHEO, Moody’s Economy.com, Milken Institute.
0
1
2
3
4
1998 2000 2002 2004 2006 20080.0
0.2
0.4
0.6
0.8Millions
Existing homes for sale (left axis)
New homes for sale (right axis)
Millions
1616
III. Subprime borrowers and subprime mortgages
1717
National FICO scores display wide distribution What goes into a FICO score?
Who is a subprime borrower?
Sources: myFICO.com, Milken Institute.
25
812
1518
27
13
0
10
20
30
40
up to499
500-549
550-599
600-649
650-699
700-749
750-799
800+
Percentage of population
Subprime = 21%
Prime = 79%
Amounts owed
30%
Payment history
35%
Length of credit history
15%
New credit10%
Types of credit in use
10%
1818
Prime
Subprime
0
4
8
12
16
20
0 - 459
460 - 4
79480
- 499
500 - 5
19520
- 539
540 - 5
59560
- 579
580 - 5
99600
- 619
620 - 6
39640
- 659
660 - 6
79680
- 699
700 - 7
19720
- 739
740 - 7
59760
- 779
780 - 7
99800
- 900
Percent of total originations
FICO score
FICO below 620 Prime: 6.6%
Subprime: 45.2%
FICO above 620 Prime: 93.4%
Subprime: 54.8%
Prime and subprime mortgage originations by FICO score reveal substantial overlaps
Sources: LoanPerformance, Milken Institute.
1919
ARMs look attractive to many borrowers
2.0
3.0
4.0
5.0
6.0
7.0
8.0
2001 2002 2003 2004 2005 2006 2007 2008
Percent
30-year FRM rate
1-year ARM rate
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
2020
ARM share grows, following low interest rates
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
0
5
10
15
20
25
2001 2002 2003 2004 2005 2006 2007 2008
Percent of all outstanding home mortgages
2121
0
10
20
30
40
50
60
2001 2002 2003 2004 2005 2006 2007 2008
FHA ARM Prime ARM Subprime ARM
Percent of mortgage type
Largest share of ARMs go to subprime borrowers
Sources: Mortgage Bankers Association, Moody’s Economy.com, Milken Institute.
2222
Subprimes take an increasing shareof all home mortgage originations
0.0
1.0
2.0
3.0
4.0
2001 2002 2003 2004 2005 2006 2007 Q2 2008
Subprime
Prime
US$ trillions
Subprime'sshare:7.8%
7.4%
8.4%
18.2%21.3%
20.1%
7.9%
0.9%
Sources: Inside Mortgage Finance, Milken Institute.
2323
160200
310
540
625 600
191
140
100
200
300
400
500
600
700
2001 2002 2003 2004 2005 2006 2007 Q22008
US$ billions US$ billions
479574
699
973
1,200 1,240
940 895
0
200
400
600
800
1,000
1,200
1,400
2001 2002 2003 2004 2005 2006 2007 Q12008
Average annual growth rates1995–2006: 14%2006–Q1 2008: -23%
Subprime mortgages increase rapidly before big declineOriginations Outstandings
Sources: Inside Mortgage Finance, Milken Institute.
H22008
2424
IV. Mortgage product innovation
2525
Subprime and Alt-A shares quadruple between 2001 and 2006, then fall in 2007
FHA & VAConventional, conforming primeJumbo prime
pSubprimeAlt-A Home equity loans
Sources: Inside Mortgage Finance, Milken Institute.
2001, $2.2 trillion
57.1%
2% 5%7.9%
7%
20%
2006, $3.0 trillion
33.2%
13%
14%2.7%
20% 16%
2007, $2.4 trillion
47.3%
11%
14% 4.9%
8%
14%
Q1 2008, $480 billion
67.2%
4% 9% 9.6%2%
8%
2626
ARM hybrids dominate subprime originations (2006)
Other ARM7%
23%
Fixed 70%
Prime conventional
ARM hybrids
Alt-A
Fixed 31%
Other ARM23%
ARM hybrids46%
Sources: Freddie Mac, Milken Institute.
SubprimeOther ARM 4%
Fixed 9%
30-yearARM balloon
with 40- to 50-year
amortization26%
2- and 3-year hybrids 61%
2727
V. Securitization
2828
The mortgage model switches fromoriginate-to-hold to originate-to-distribute
Held in portfolio
84.4%
Securitized15.6%
Held in portfolio
41%
Securitized59%
Residential mortgage loans1980: Total = $958 billion
Residential mortgage loansQ2 2008: Total = $11.3 trillion
Sources: Federal Reserve, Milken Institute.
2929
31 2933
4045 43 42 45 47 50
5762
65 68 68 68
0
10
20
30
40
50
60
70
80
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q12008
Q22008
Percent of all subprime mortgages securitized since 1994
Securitization becomes the dominant fundingsource for subprime mortgages
Sources: Inside Mortgage Finance, Milken Institute.
3030
The rise and fall of private-label securitizers
Ginnie Mae Freddie Mac Fannie Mae Private-label
New securities issuance
Sources: Inside Mortgage Finance, Milken Institute.
21%
2%42%
35%
1985Total = $110B
29%
13%20%
38%
2001Total = $1.3T
18%
4%
56%
22%
2006Total = $2.0T
33%
15%6%
46%
First half 2008Total = $734B
3131
The rise and fall of private-label securitizersOutstanding securities
Ginnie Mae Freddie Mac Fannie Mae Private-label
13%
6%
55%
26%
1985Total = $390B
39%
14% 18%
29%
2001Total = $3.3T
33%
35%7%
25%
2006Total = $5.9T
37%
30%7%
26%
First half 2008Total = $6.8T
Sources: Inside Mortgage Finance, Milken Institute.
3232
VI. Affordability
3333
2.5
3.0
3.5
4.0
4.5
5.0
1998 2001 2004 2007
Median home price/median household income
Average, 1967–2007: 3.38
2005: 4.69
2007: 4.29
Ratio of home price to household
income surges
Home mortgage share of household debts reaches
a new high in 2007
Debt-to-income ratio of households has increased rapidly
Sources: U.S. Census Bureau, OFHEO, Federal Reserve, Moody’s Economy.com, Milken Institute.
75
100
125
150
1998 2001 2004 2007
Home mortgage debt/disposable personal income
Q4 2007: 139.5%
Average, 1957–2007: 79.7%
60
65
70
75
1998 2001 2004 2007
Percent Q2 2007: 73.7%
Q2 2008: 73.4%
Average, 1952–2008: 64.2%
3434
VII. Collapse
3535
The recent run-up of home prices was extraordinary
0
50
100
150
200
250
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
WorldWar I World
War II1970’sboom
1980’sboom
Currentboom
Long-term trend line
Annualized growth rate of nominal home index: 3.4%
Index, 2000 = 100
GreatDepression
Sources: Robert Shiller, Milken Institute.
3636
Home prices don’t go up foreverChange in home prices in 100 plus years
-20
-15
-10
-5
0
5
10
15
20
25
30
1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
WorldWar I
GreatDepression
WorldWar II
1970’sBoom
1980’sBoom
CurrentBoom
Average, 1890–2007: 3.7%
Percentage change in nominal home price, year ago
+/- one standard deviation
Sources: Robert Shiller, Milken Institute.
3737
2005: The collapse begins
Sources: S&P/Case-Shiller, OFHEO, Moody’s Economy.com, Milken Institute.
S&P/Case-Shiller 10 city
OFHEO
S&P/Case-Shiller national
-15
-10
-5
0
5
10
15
20
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Home price indices, percent change on a year earlier
3838
Forty-six states had falling prices in the fourth quarter 2007
United States: - 9.3% (fourth-quarter annualized growth)
Source: Freddie Mac.
3939
48.448.0
28.227.926.826.326.326.0
24.422.9
20.518.6
14.39.1
6.66.56.15.94.8
-0.7-3.8
-21.3
SeattlePortlandWashingtonNew YorkPhoenixLos AngelesTampaMiamiLas VegasCharlotteComposite 10Composite 20ChicagoSan FranciscoAtlantaDallasSan DiegoBostonDenverMinneapolisClevelandDetroit
One year ago… Five years ago…If you bought your house…
% change in price, June 07-08 % change in price, June 03-08Sources: S&P/Case-Shiller, Milken Institute.
-1.0-3.2
-4.7-5.2
-5.8-7.1-7.3-7.3
-8.1-9.5
-13.9-15.7-15.9-16.3
-17.0-20.1
-23.7-24.2
-25.3-27.9-28.3-28.6
CharlotteDallasDenverBostonPortlandSeattleNew YorkClevelandAtlantaChicagoMinneapolisWashingtonComposite 20 DetroitComposite 10TampaSan FranciscoSan DiegoLos AngelesPhoenixMiamiLas Vegas
4040
Housing startssharply decline
Homes sit longeron the market …
… as home appreciation slows
Note: Shaded area represents fluctuation within one standard deviation from mean (1.28%)Sources: Mortgage Bankers Association, OFHEO, Moody’s Economy.com, Milken Institute.
-60
-45
-30
-15
0
15
30
1998 2000 2002 2004 2006 2008
June 2008: -41.9%July 2008: -39.2%
Percent change, year ago
0
2
4
6
8
10
12
1998 2000 2002 2004 2006 2008
Number of months that homes sit on the market
Existing homes
New homes
-20
-10
0
10
20
1999 2001 2003 2006 2008
0
2
4
6
8
10
12
Percentage change from year ago in m edian hom e sales price (le ft axis)
Num ber of m onths hom es stay on
m arket (r ight axis)
Percent Months
4141
VIII. Delinquencies and foreclosures
4242
400
650
900
1,150
1,400
1,650
1,900
2,150
Q2 1999
Q4 1999
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q2 2002
Q4 2002
Q2 2003
Q4 2003
Q2 2004
Q4 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Thousands of foreclosures per year
Average 661,362 annual foreclosures from Q2 1999 to Q2 2006
Foreclosures are nothing new, but …
Sources: Mortgage Bankers Association, Milken Institute.
4343
… their numbers have doubled
Sources: Mortgage Bankers Association, Milken Institute.
400
650
900
1,150
1,400
1,650
1,900
2,150
Q2 1999
Q4 1999
Q2 2000
Q4 2000
Q2 2001
Q4 2001
Q2 2002
Q4 2002
Q2 2003
Q4 2003
Q2 2004
Q4 2004
Q2 2005
Q4 2005
Q2 2006
Q4 2006
Q2 2007
Q4 2007
Q2 2008
Thousands of foreclosures per year
Average 661,362 annual foreclosures from Q2 1999 to Q2 2006
Average 1,316,220 annual forclosures from Q3 2006 to Q2 2008
4444
Subprime mortgages accounted for half or more of foreclosures since 2006
0
400
800
1,200
1,600
2,000
Dec. 2003 June2004
Dec. 2004 June2005
Dec. 2005 June2006
Dec. 2006 June2007
Dec. 2007 March2008
SubprimeFHA and VAPrime (includes Alt-A)
Subprime: 12% of mortgages serviced (March 2008)
37%
29%
34%
36%
29%
35%
37%
29%
34%
44%
22%
34%
47%
20%
33%
52%
17%31%
55%
13%
32%
56%
11%
33%
54%
9%
37%
Number of home mortgage foreclosures started (annualized, in thousands)
50%
8%
42%
Sources: Inside Mortgage Finance, Milken Institute.
4545
Subprime ARMs have the worst default recordHome mortgages delinquent or in foreclosure (percent of number)
0
5
10
15
20
25
30
35
Q21998
Q11999
Q41999
Q32000
Q22001
Q12002
Q42002
Q32003
Q22004
Q12005
Q42005
Q32006
Q22007
Q12008
Q2 2008, Subprime ARM: 33.4%
Subprime FRM: 11.8%
Prime FRM: 3.0%
FHA and VA: 5.8%
Sources: Mortgage Bankers Association, Milken Institute.
4646
Percentage of homes purchased in Q2 2008 that now have negative equity
< 20%>= 20% and < 35%>= 35% and < 50%>= 50%
Sources: Zillow.com, Milken Institute.
United States = 44.8%
4747
Percentage of homes sold for a loss (Q2 2008)
< 15%>= 15% and < 30%>= 30% and < 45%>= 45%
Sources: Zillow.com, Milken Institute.
United States = 32.7%
4848
Percentage of homes sold that were in foreclosure (Q2 2008)
< 1%>= 1% and < 25%>= 25% and < 40%>= 40%
Sources: Zillow.com, Milken Institute.
United States = 18.6%
4949
IX. Damages scorecard
5050
Losses/write-downs, capital raised, and jobs cut by financial institutions worldwide
Note: Q3 data are through September 25, 2008.Sources: Bloomberg, Milken Institute.
0
40
80
120
160
200
Prior quarters Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 20080
12,000
24,000
36,000
48,000
60,000US$ billions
Losses/write-downs(left axis)
Capital raised(left axis)
Jobs cut (right axis)
Number of jobs cut
5151
What is the cumulative damage?
Note: Q3 data are through September 25, 2008.Sources: Bloomberg, Milken Institute.
Cumulative losses/write-downs, capital raised, and jobs cut by financial institutions worldwide
0
100
200
300
400
500
600
Prior quarters Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 20080
20,000
40,000
60,000
80,000
100,000
120,000
140,000Number of jobs cut US$ billions
Losses/write-downs (left axis)
Capital raised (left axis)
Jobs cut (right axis)
5252
Recent losses/write-downs and capital raised by selected financial institutions
379.2521.9World total
23.514.4Royal Bank of Scotland, United Kingdom
12.114.8Washington Mutual, United States
12.315.0IKB Deutsche, Germany
5.615.7Morgan Stanley, United States
20.721.2Bank of America, United States
11.022.7Wachovia, United States
5.127.4HSBC, United Kingdom
28.244.2UBS, Switzerland
29.952.2Merrill Lynch, United States
49.155.1Citigroup, United States
Capital raisedLosses /write-downsUS$ billions, through September 25, 2008
Sources: Bloomberg, Milken Institute.
5353
Financial stock prices take big hits
Note: * Bear Stearns stock price is to May 2008. ** Countrywide stock price is to June 2008.Sources: Bloomberg, Milken Institute.
-99.8-99.7
-97.5-97.4
-95.4-94.3-93.9
-90.0-72.8
-66.0-65.6
-35.8-34.4
-3.35.5
Washington MutualLehman BrothersFreddie MacFannie MaeAIGBear Stearns*WachoviaCountrywide**Merrill LynchMorgan StanleyUBS EquityGoldman SachsBank of AmericaJP Morgan & ChaseWells Fargo
Percentage change in stock price, December 2006–September 2008
5454
-142-101
-80-74
-60-50
-44-43-42-41
-28-24-21
417
AIGWachoviaBank of AmericaUBS EquityMorgan StanleyFannie MaeMerrill LynchWashington MutualFreddie MacLehman BrothersGoldman SachsCountrywide**Bear Stearns*Wells FargoJP Morgan & Chase
Total loss in market value: $728 billion, December 2006–September 2008
Financial market capitalization takes big hit
Note: * Bear Stearns stock price is to May 2008. ** Countrywide stock price is to June 2008.Sources: Bloomberg, Milken Institute.
US$ billions
5555
X. Credit crunch and liquidity freeze
5656
Tightened standards for real estate loans
Sources: Federal Reserve, Milken Institute.
-40
-20
0
20
40
60
80
100
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Net percentage of domestic respondents tightening standards for commercial real estate loans
LTCM DotcomThe end of S&L crisis
Subprime
5757
Widening spreads betweenmortgage-backed and high-yield bonds
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
01/2004 07/2004 01/2005 07/2005 01/2006 07/2006 01/2007 07/2007 01/2008 07/2008
Basis points, spread over 10-year Treasury bond
Merrill Lynch Mortgage-Backed Securities Index
Merrill Lynch High-Yield Bond Index
Maximum spread: 08/29/2008: 955.8 bps
Sources: Merrill Lynch, Bloomberg, Milken Institute.
5858
Liquidity freeze
0
20
40
60
80
100
120
140
2006 2007 2008
Average s ince Decem ber 2001: 21.1 bps
Septem ber 19, 2008: 127.5 bps
Basis points
Average s ince August 2007: 69.8 bps
Spread between 3-month LIBOR and overnight index swap rate
Sources: Bloomberg, Milken Institute.
Spread between 3-month LIBOR and T-bill rate
0
50
100
150
200
250
300
350
2006 2007 2008
August 20, 2007: 240 bps
Average s ince 1985: 76 bps
Average s ince August 2007: 130 bps
Basis points
Septem ber 18, 2008: 313 bps
5959
Counterparty risk increases
Note: Counterparty Risk index averages the market spreads of the credit default swaps (CDS) of fifteen major credit derivatives dealers, including ABN Amro, Bank of America, BNP Paribas, Barclays Bank, Citigroup, CreditSuisse, Deutsche Bank, Goldman Sachs Group, HSBC, Lehman Brothers, JPMorgan Chase, Merrill Lynch, Morgan Stanley, UBS, and Wachovia. Sources: Datastream, Milken Institute.
0
100
200
300
400
500
07/2007 09/2007 11/2007 01/2008 03/2008 05/2008 07/2008 09/2008
Basis points
Bear Stearns acquired
Government announces support for Fannie Mae and Freddie Mac
Lehman Brother files for bankruptcy and Merrill Lynch acquired
AIG rescued
Average CDS spread, basis points
6060
Commercial paper issuance dries up
Sources: Federal Reserve, Milken Institute.
-200
-150
-100
-50
0
50
100
150
Q1 2006 Q2 2006 Q3 2006 Q4 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008
Issuers of asset-backed securities
Other issuers
Quarterly change in outstanding amount, US$ billions
6161
Federal Reserve responds by cutting Fed funds rate, but mortgage rates remain relatively flat
0
12
3
45
6
7
89
10
01/2007 03/2007 06/2007 09/2007 12/2007 02/2008 05/2008 08/20080.0
0.51.0
1.5
2.02.5
3.0
3.5
4.04.5
5.0
Freddie Mac 30-year fixed mortgage rate (left axis)
Federal funds rate (left axis)
Percent Percent
30-year FRM rate (left axis)
Spread (right axis)
Sources: Freddie Mac, Federal Reserve, Moody’s Economy.com, Milken Institute.
6262
Congress and White House responsesHOPE NOWThe Economic Stimulus Act of 2008Housing and Economic Recovery Act of 2008 Conservatorship of Fannie Mae and Freddie MacTemporary guaranty program for money market fundsTemporary ban on short selling in selected companies Bailout package?
6363
XI. When will we hit bottom?
6464
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 to a downturn?
Yes 27%
No 73%
When will home prices hit bottom?
4%
17%
38%
29%
6%
1st half2008
2nd half2008
1st half2009
2nd half2009
1st half2010
Source: Wall Street Journal.
6565
How far do home prices have to fall?
Sources: Davisa, Lehnertb, Martin (2007), Milken Institute.
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Q2 1971: 6.08%Annual rents as percent of home prices
Q4 2006: 3.48%
Q1 2008: 3.93%Average, 1960–Q1 2008: 5.04%
Average, 2000–Q1 2008: 4.06%
6666
Combinations of rental price growth rates and rent-to-price ratios to get home prices back to their Q4 2006 value
Annual home price decline -2.0% -5.0% -10.0% -15.0% -20.0%
3.80% 2010 Q3 2008 Q4 2008 Q2 2008 Q2 2008 Q2
4.00% 2013 Q1 2009 Q4 2008 Q3 2008 Q2 2008 Q2
5.00% 2024 Q1 2014 Q1 2010 Q4 2009 Q3 2009 Q1
5.04% average 2024 Q3 2014 Q2 2010 Q4 2009 Q3 2009 Q1
Ren
t-to-
pric
e ra
tio
6.00% 2026 Q4 2017 Q3 2012 Q3 2010 Q4 2009 Q4
Annual home price decline required
Sources: Davisa, Lehnertb, Martin (2007), Milken Institute.
6767
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
US$/month
Payment with 100% LTVPayment with 90% LTVPayment with 80% LTV
Maximum affortablility limit is 38% of median household
Mortgage payment assumptions: Every month, a home is purchased at median price, buyer takes out a 30-year conforming, fixed-rate loan with 80% LTV. Payment also includes 1% property tax per year, 0.1% property insurance.
Alternative measures of the affordability of mortgage debt for California
Sources: Moody’s Economy.com, Milken Institute.
6868
XII. What went wrong
6969
2,443
879
1,410
2,067
944886
0
500
1,000
1,500
2,000
2,500
3,000
Fannie Mae:total assets
Fannie Mae:total MBS
outstanding
Freddie Mac:total assets
Freddie Mac:total MBS
outstanding
Commercialbanks: total
residential realestate assets
Savingsinstitutions:
totalresidential realestate assets
US$ billions
The importance of Fannie Mae and Freddie Mac
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
7070
Fannie Mae and Freddie Mac: Too big with too little capital?
Sources: Freddie Mac, Fannie Mae, Milken Institute.
133 41
1,022803 844 805 886 879
288 316
1,301
752
1,778
1,123
2,443
1,410
0
500
1,000
1,500
2,000
2,500
3,000
Fannie Mae1990
Freddie Mac1990
Fannie Mae2003
Freddie Mac2003
Fannie Mae2006
Freddie Mac2006
Fannie Mae2Q 2008
Freddie Mac2Q 2008
US$ billions
Total assets
Total MBS outstanding
7171
60x 56x 48x 55x60x 58x 52x 57x64x81x
56x
167x
65x
244x
59x
0
50
100
150
200
250
300
Core capital Fair value Core capital Fair value
2005 2006 2007 2008Q2
Mortgage book of business over capital measures
Fannie Mae Freddie Mac
-393x
Fannie Mae and Freddie Mac are highly leveraged
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
7272
Freddie Mac’s and Fannie Mae's retained private-label portfolios
Sources: Freddie Mac, Fannie Mae, FDIC, Milken Institute.
Fannie Mae, 2007
Fannie Mae, 2006
Fannie Mae, 2005
Freddie Mac, 2007
Freddie Mac, 2006
Subprime Alt-A All others
33.8% 4.3% 32.0%
46.4% 36.1% 17.5%
32.1% 37.4% 30.5%
57.4% 13.1% 29.5%
61.2% 25.0% 13.8%
$122.2 billio
$76.1 billion
$86.9 billion
$97.3 billion
$94.8 billion
7373
9.1
9.8
9.4
31.6
23.7
21.5
67.9
Credit unions
Commercial banks
Savings institutions
Brokers/hedge funds
Federal Home Loan Banks
Fannie Mae
Freddie Mac
Leverage ratio, total assets/common equtity
Leverage ratios of different types of financial firms (June 2008)
Sources: Federal Deposit Insurance Corporation, Office of Federal Housing Enterprise Oversight, National Credit Union Administration, Bloomberg, Google Finance, Milken Institute.
7474
Too much dependence on debt?Leverage ratios at biggest investment banks
Sources: Bloomberg, FDIC, Milken Institute.
28
1922
26
18
27
19
31
24 23
34 32 3331
22
2830
2422
n.a.0
5
10
15
20
25
30
35
40
Bear Stearns Merrill Lynch Morgan Stanley Lehman Brothers Goldman Sachs
2000 2005 2007 June 2008Total assets/total shareholder equity
7575
AAAAA+
AAAA-A+
AA-
BBB+BBBBBB-
BB+BBBB-B+BB-CCC+
CCC+CCC-CCC
D
0 1,000 2,000 3,000 4,000 5,000Number of securities rated
4,090, or 51%, of new securities rated by S&P were rated AAA
Most new securities issued in 2007 were rated AAA by S&P
56.0%6,31011,261Total
87.5%78B(+/-)
86.6%683789BB(+/-)
76.1%2,2482,954BBB(+/-)
63.2%1,8862,983A(+/-)
38.1%1,3303,495AA(+/-)
15.1%1561,032AAA
Downgraded/ Total
DowngradedTotalS&P
56 percent of MBS issued from 2005 to 2007 were eventually
downgraded
Sources: Bloomberg, Inside Mortgage Finance, Milken Institute.
Note: A bond is considered investment grade if its credit ratingis BBB- or higher by S&P
7676
When is a AAA not a AAA?Multilayered mortgage products
Sources: International Monetary Fund, Milken Institute.
Origination ofmortgage loans High-grade CDO
Senior AAA 88%Junior AAA 5%
Pool of mortgage AA 3%loans: prime or subprime A 2%
BBB 1%Unrated 1%
Mortgage bonds
AAA 80%AA 11%A 4% Mezzanine CDO
BBB 3% CDO-squaredBB-unrated 2% Senior AAA 62%
Junior AAA 14% Senior AAA 60%AA 8% Junior AAA 27%A 6% AA 4% CDO-cubed…
BBB 6% A 3%Unrated 4% BBB 3%
Unrated 2%
7777
Dollar losses in reported cases of mortgage fraud
US$ millions
293225
429
1,014946
813
0
200
400
600
800
1,000
1,200
2002 2003 2004 2005 2006 2007
Mortgage loan fraud surges
Sources: Financial Crimes Enforcement Network, Federal Bureau of Investigation, Milken Institute.
1.7
2.3 2.9 3.5 4.7 5.49.5
18.4
26.0
37.3
52.9
0
10
20
30
40
50
60
1997 1999 2001 2003 2005 2007
Number of cases reported, thousands
1.7
2.3 2.9 3.5 4.7 5.49.5
18.4
26.0
37.3
52.9
0
10
20
30
40
50
60
1997 1999 2001 2003 2005 2007
Number of cases reported, thousands
7878
Is adequate information disclosed to consumers?
Sources: Federal Trade Commission, Milken Institute.
20202123
303233
3751
6874
7984
8795
APR amountCash due at closing amount
Monthly payment (including whether it includes taxes and insurance)Settlement charges amount
Balloon payment (presence and amount)Interest rate amount
Whether loan amount included finances settlement chargesWhich loan was less expensive
Loan amountPresence of prepayment penalty for refinance in two years
Presence of charges for optional credit insuranceReason why the interest rate and APR sometimes differProperty tax and homeowner’s insurance cost amount
Total up-front cost amountPrepayment penalty amount
Percent of respondents who could not correctly identify various loan costs using current disclosure forms
7979
Drivers of foreclosures:Strong appreciation or weak economies?
Sources: U.S. Treasury Department, RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute.
0
5
10
15
20
25
-20 0 20 40 60 80 100 120 140
Five-year price gain, Q3 2002–Q3 2007 (percent)
Detroit
MiamiBakersfield
Riverside
Fresno
Fort Lauderdale
Orlando
Phoenix
Las Vegas
Palm Beach
Tampa
Stockton
San Diego
Oakland
Sacramento
Atlanta
MemphisColumbus
Indianapolis
ToledoDaytonDenver
Cleveland
Akron
Warren
Weak economies Housing bubbles
Foreclosures per 1,000 homes
National average
8080
After housing bubble burst in 2007: Foreclosures highest for areas with biggest price declines
Sources: RealtyTrac, Office of Federal Housing Enterprise Oversight, Milken Institute.
0
5
10
15
20
25
30
35
40
45
-30 -25 -20 -15 -10 -5 0 5
Price change, 2007–June 2008 (percent, annualized)
Weak economies strengthenStockton
Miami
Orlando
Bakersfield
Phoenix
RiversideLas Vegas
Fort Lauderdale
Fresno
SacramentoOakland
San DiegoDetroit
Warren ClevelandDayton
Columbus Indianapolis
Palm BeachTampa
ToledoAkron
Denver
Atlanta
Memphis
Foreclosures per 1,000 homes
National average
Collaping housing bubbles
8181
XIII. Where do we go from here?
8282
The U.S. regulatory regime: In need of reform?
National banks State commercial and savings banks
Federal savings banks
Insurance companies
Securities brokers/dealers
Other financial companies, including mortgage
companies and brokers
• Fed• OTS
• OCC• FDIC
• State bank regulators• FDIC• Fed--state member commerical banks
• OTS• FDIC
• 50 State insurance regulators plus District of Columbia and Puerto Rico
• FINRA• SEC• CFTC• State securities regulators
• Fed• State licensing (if needed)• U.S. Treasury for some products
• OCC• Host county regulator
• Fed• Host county regulator
• OTS• Host county regulator
Federal branch
Foreign branch
Limited foreign branch
Fed is the umbrella or consolidated regulator
Primary/secondaryfunctionalregulator
Notes:Justice Department: Assesses effects of mergers and acquisitions on competitionFederal Courts: Ultimate decider of banking, securities, and insurance productsCFTC: Commodity Futures Trading CommissionFDIC: Federal Deposit Insurance CorporationFed: Federal ReserveFINRA: Financial Industry Regulatory Authority GSEs: Government Sponsored Enterprises OCC: Comptroller of the CurrencyOTS: Office of Thrift SupervisionSEC: Securities and Exchange Commission
• Federal Housing Finance Agency
Fannie Mae, Freddie Mac, and Federal Home Loan Banks
Financial, bank and thrift holding companies
Sources: Financial Services Roundtable (2007), Milken Institute.
8383
Many different options and innovations…
Covered BondsCovered Bonds
Alternative Mortgage ProductsAlternative Mortgage Products
Shared Equity MortgagesShared Equity Mortgages
Real Estate DerivativesReal Estate Derivatives
Classical Insurance Products Classical Insurance Products
OthersOthers
8484
Demystifying the Mortgage Meltdown:What It Means for Main Street,
Wall Street and the U.S. Financial System
Milken InstituteOctober 2, 2008
Glenn Yago Director of Capital Studies
James R. Barth Senior Fellow