u.s. subprime mortgage market meltdown u.s. subprime mortgage market meltdown james r. barth auburn...

U.S. Subprime U.S. Subprime Mortgage Market MeltdownMortgage Market Meltdown

James R. BarthAuburn University and Milken Institute

[email protected]

14th Dubrovnik Economic ConferenceThe Croatian National Bank

Dubrovnik, CroatiaJune 25–28, 2008

“Any real-estate investment is a good investment … ”

… NOT!… NOT!

“Any real-estate investment

is a good investment … ”

62

63

64

65

66

67

68

69

70

1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005

Percent

Homeownership Rate Reaches Historic High in 2004

69.2% in September 2004

67.8% in March 2008

Source: U.S. Census Bureau.

2008

Home Prices Peak in 2006

Sources: U.S. Office of Federal Housing Enterprise Oversight (OFEHO), Standard & Poor's, California Association of Realtors, Moody's Economy.com.

S&P/Case-Shillerhome price index

OFHEO conventional and conforming home

price index

California median home price

0

100

200

300

400

500

600

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Index, January 1987 = 100



price index


0

100

200

300

400

500

600

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008




price index


0

100

200

300

400

500

600

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008


S&P/Case-Shiller 10 city

OFHEO

S&P/Case-Shiller national

-15

-10

-5

0

5

10

15

20

1988 1992 1996 2000 2004 2008

Home Price Appreciation Peaks in 2005

House-price indices, % change on a year earlier

A Longer-Term Perspective on Home Prices

Source: Robert J. Shiller, 2006.

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

1890=100

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

1890=100

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

1890=100

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

60

80

100

120

140

160

180

200

220

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

100

120

140

160

180

200

220

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

1890=100

80

60

-20%

-10%

0%

10%

20%

30%

40%

1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

WorldWar I

GreatDepression

WorldWar II

1970’sBoom

1980’sBoom

CurrentBoom

History Repeats Itself: Home Prices Don’t Just Go Up

Change in Home Prices in 100 plus years Percentage change, year ago

Source: Robert J. Shiller, 2006.

Homes for Sale Take Off


0.0

0.6

1.2

1.8

2.4

3.0

3.6

4.2

4.8

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Existing homes (Left axis)

New homes (Right axis)

0.0

0.6

1.2

1.8

2.4

3.0

3.6

4.2

4.8

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8



Millions Millions

20082007200620052004200320022001200019991998

6.5

6.0

5.5

5.0

4.5

4.0

1.4

1.2

1.0

0.8

0.6

0.4

Millions, SAAR Millions, SAAR

Single-family Home Sales Reach New High Before Plunging

Sources: U.S. Census, National Association of Realtors, Moody’s Economy.com.



Existing Home Sales Are Down Everywhere Over the Past Two Years

Source: Freddie Mac.

Percent change in existing home sales Fourth-quarter 2005 through fourth-quarter 2007

Existing home sales nationwide down 29%

Median Existing Single-family Home Price: Too Good to Last

Sources: National Association of Realtors, Moody’s Economy.com.

20082007200620052004200320022001200019991998

20

15

10

5

0

-5

-10

-15

Percent change, year ago

Forty-six States Had Falling Prices in the Fourth Quarter 2007


United States: - 9.3% (fourth-quarter annualized growth)

Single-family Housing Starts

Sources: U.S. Census Bureau, Global Insight.

20082007200620052004200320022001200019991998

40

20

0

-20

-40

-60

Percent change, year ago

Single-family Building Hit a Record in 2005 But Was 53% Lower Two Years Later

Thousands, SAAR

Housing starts: Single-family privately owned

0200400600800

1,0001,2001,4001,6001,8002,000


20082007200620052004200320022001200019991998

4.0

3.5

3.0

2.5

2.0

1.5

1.0

11

10

9

8

7

6

5

4

3

Millions Months

Homes Sit Longer on the Market

Sources: National Association of Realtors, Moody’s Economy.com.

Months supply (Right axis)

Homes available for sale

(Left axis)

Home Prices and Credit Boom


S&P/Case-Shiller®

home price index (L)

Total originations

(R)

Subprime originations

(R)

0

50

100

150

200

250

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500US$ billions

20082007200620052004200320022001200019991998

7

6

5

4

3

2

1

0

Percent

Interest Rates: Too Low Too Long? Fed Funds Rate vs. Rate on Long-term Government Bonds

Sources: Federal Reserve, Global Insight.

Fed funds rate

Government bond rate

200820072006200520042003200220012000199919981997

9.0

8.0

7.0

6.0

5.0

4.0

3.0

2.0

Percent

Sources: Mortgage Banker’s Association, Moody’s Economy.com.

30-yr fixed

1-yr ARM

Mortgage Rates: ARMs Appear Attractive to Many

ARM Share of Mortgages

Sources: U.S. Federal Housing Finance Board, Freddie Mac, Moody’s Economy.com.

200820072006200520042003200220012000199919981997

40

35

30

25

20

15

10

5

Percent

Share of all applications

Share of all loans

ARM Share of Mortgages

Source: Mortgage Bankers Association.

11.7 12.0 11.9

14.814.4

15.8

16.9

17.9

19.0

20.220.6 20.9

21.721.3 21.4

21.1 20.920.2

20.9 20.8

9

11

13

15

17

19

21

23

Percent of all loans

ARM Mortgage Share by Loan Type

Source: Mortgage Bankers Association.

0

10

20

30

40

50

60

70

FHAPrimeSubprime

Percent of loan type

Prime and Subprime Home Mortgage Originations

YearTotal Originations

(US$ Trillions)

Share of Total (%)

Prime Originations

SubprimeOriginations

1994 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.

Conventional, conforming prime Jumbo prime

Subprime Alt-A

FHA & VA Home equity loans

Conventional, conforming prime Jumbo prime

Subprime Alt-A

FHA & VA Home equity loansSource: Inside Mortgage Finance.

2001 $2.2 trillion

19.4%

8.4%

4.6%

2.6% 8.0%

56.9%

2006 $3.0 trillion

16.1%20.1%

14.4%

13.4%

2.7%

33.2%

2007 $2.4 trillion

14.3%

7.9%

14.4%

11.3%

4.9%

47.3%

2001 $2.2 trillion

19.4%

8.4%

4.6%

2.6% 8.0%

56.9%

2006 $3.0 trillion

16.1%20.1%

14.4%

13.4%

2.7%

33.2%

2007 $2.4 trillion

14.3%

7.9%

14.4%

11.3%

4.9%

47.3%

Subprime

Other ARM 4%Fixed

9%

30Yr ARM Balloon W/

40-50-Yr Amtz 26%

2-year & 3-year hybrids 61%

Primeconventional

Fixed 70%

ARM Hybrids23%

Other ARM7%

Alt-A

ARMhybrids46%Fixed

31%

Other ARM23%

Subprime

Other ARM 4%Fixed

9%

30Yr ARM Balloon W/

40-50-Yr Amtz 26%


Primeconventional

Fixed 70%

ARM Hybrids23%

Other ARM7%

Alt-A

ARMhybrids46%Fixed

31%

Other ARM23%

Subprime

Other ARM 4%Fixed

9%

30Yr ARM Balloon W/

40-50-Yr Amtz 26%


Primeconventional

Fixed 70%

ARM Hybrids23%

Other ARM7%

Alt-A

ARMhybrids46%Fixed

31%

Other ARM23%

Subprime

Other ARM 4%Fixed

9%

30Yr ARM Balloon W/

40-50-Yr Amtz 26%


Primeconventional

Fixed 70%

ARM Hybrids23%

Other ARM7%

Alt-A

ARMhybrids46%Fixed

31%

Other ARM23%

2/28 ARMs Dominate Subprime Home-purchase Loan Originations in 2006


Other ARM

Subprime Mortgage Loans Outstanding


US$ billions

344 382 416

574

973

699

479319

283290

1,200

940895

1,240

0

200

400

600

800

1,000

1,200

1,400

Distribution of Prime and Subprime Residential Mortgage Originations by FICO Score

(2006)

PrimeSubprime

0%

2%

4%

6%

8%

10%

12%

14%

16%

Percent of Total Originations

FICO Score

National Distribution of FICO Scores

2

5

8

12

15

18

27

13

0

5

10

15

20

25

30

up to499

500-549 550-599 600-649 650-699 700-479 750-799 800

Percentage of Population

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

Source: Securities Industry and Financial Markets Association.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1999 2000 2001 2002 2003 2004 2005 2006 2007

US$ trillionsOther

Student Loans

Home Equity

Credit Card

Automobile

Non-agencyMBSAgency CMO

Agency MBS

U.S. Asset-backed Securities Outstanding

Source: Securities Industry and Financial Markets Association.

Agency MBS54%

Agency CMO16%

Non-agency MBS9%

Automobile3%

Credit Card6%

Home Equity3%

Student Loans1%

Other8%

Agency MBS46%

Agency CMO14%

Non-agency MBS14%

Automobile2%

Credit Card4%

Home Equity6%

Student Loans3%

Other11%

1999, Total = US$4,235 Billions 2007, Total = US$9,682 Billions

Home Mortgage Security Issuance

1985, Total = $110 Billion

Non-Agency

2%FNMA21%

FHLMC35%

GNMA42%

2006, Total = $2.1 Trillion

GNMA4% FHLMC

18%

FNMA22%

Non-Agency

56%


GNMA5%

FHLMC24%

FNMA33%

Non-Agency

38%

Outstanding Home Mortgage Securities

1986, Total = $548 Billion

Non-Agency

MBS3%Fannie

Mae MBS18%

Freddie Mac PCs

31%

Ginnie Mae MBS

48%


Ginnie Mae MBS

7%

Freddie Mac PCs

26%

Fannie Mae MBS

35%

Non-Agency

MBS32%


Ginnie Mae MBS

7%

Freddie Mac PCs

26%

Fannie Mae MBS

35%

Non-Agency

MBS32%

Private-label Mortgage-backed Security Issuance Has Fallen Sharply


Dollar amount of Issuance, US$ billions

85 94 99 97 101

1920 14

3437

8

52 30

16

7

0

50

100

150

200

Subprime & other

Alt-A

Prime Jumbo

Freddie Mac &Fannie Mae

Dollar amount of Issuance, US$ billions

85 94 99 97 101

1920 14

3437

8

52 30

16

7

0

50

100

150

200

Subprime & other

Alt-A

Prime Jumbo

Freddie Mac &Fannie Mae

March 2007$191 Billion

June 2007$181 Billion

Sep. 2007$137 Billion

Dec. 2007$109 Billion

April 2008$102 Billion

Origination Shares of Mortgage Brokers Account for Majority of Home Mortgage Originations

Source: Wholesale Access.

80%

2006 Number of mortgage brokers:

53,000

Others42% Brokers

58%


7,000

Others

Brokers20%


53,000

Others42% Brokers

58%


7,000

Others

Brokers20%

Monoline Insurers’ Financial Guarantees of Securities Increase, But What Happens If They Cannot Be Honored?

19%

6%19%

11%

45%

Mortgage-BackedSecurities: U.S.

Other Asset-Backed Securities:U.S.Mortgage-BackedSecurities:InternationalOther Asset-Backed Securities:InternationalOther

Structured Finance,

$2.2 Trillion, 62%

Public Finance, $1.3 Trillion,

38%

Net Par Outstanding = $3.5 TrillionDecember 2006

34%15%

15%

8%28%

GeneralObligation

UtilityRevenue

Tax-BackedRevenue

TransportationRevenue

Other

Securitization: Originate to Distribute vs. Originate to Hold

0%

20%

40%

60%

80%

100%

1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

OtherNon-Agency

Issuers

Government-Sponsored

Enterprises and Agencies

Saving Institutions

Commercial Banks

Subprime Crisis Overview December 2006–March 2008

Sources: BusinessWeek (March 31, 2008), Standard & Poor’s and Global Insight.

1,600

1,550

1,500

1,450

1,400

1,350

1,300

1,250

S&P 500 Index

Dec. 06: OwnitMortgage, a subprime

lender, files for bankruptcy

Apr. 07: New Century, a mortgage broker, files for bankruptcy

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

Aug. 07: Fed cuts discount rate to

5.75%

Jan. 11, 08: BofA agrees to buy Countrywide

Jan. 30, 08: Fed cuts discount rate to 3.5%

Mar. 18, 08: Fed cuts discount rate to 2.4%; Fed

funds rate to 2.25%

Mar. 11, 08: Fed offers troubled banks as

much as $200 billion

Mar. 16, 08: JP Morgan offers

to buy Bear Stearns

2008 Q12006 Q4

Oct. 07: Merrill announces $7.9b in subprime write-downs, surpassing Citi’s

$6.5 billion

2007 Q1 2007 Q2 2007 Q3 2007 Q4

1,600

1,550

1,500

1,450

1,400

1,350

1,300

1,250

S&P 500 Index







file for bankruptcy


5.75%




funds rate to 2.25%




to buy Bear Stearns

1,600

1,550

1,500

1,450

1,400

1,350

1,300

1,250

S&P 500 Index1,600

1,550

1,500

1,450

1,400

1,350

1,300

1,250

S&P 500 Index







file for bankruptcy


5.75%




funds rate to 2.25%




to buy Bear Stearns

2008 Q12006 Q4

Oct. 07: Merrill announces $7.9b in subprime write-downs, surpassing Citi’s

$6.5 billion

2007 Q1 2007 Q2 2007 Q3 2007 Q4

Ratio of Median Home Price to Median Household Income Surges

2.5

3.0

3.5

4.0

4.5

5.0

'68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06

Median Home Price/Median Household Income

55

60

65

70

75

1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

Percent

Home Mortgage Share of Household Liabilities Reaches a New High in 2007

Source: Federal Reserve.

Leverage of U.S. Households has Increased Rapidly Since 1980

Home mortgage debts as % of disposable personal income

Sources: Federal Reserve and Moody’s.

55

60

65

70

75

1952 1956 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

Percent

Sixty-day plus Home Mortgage Delinquency Rates Are on the Rise

Alt A

Jumbo prime

Subprime

0%

5%

10%

15%

20%

25%

Sources: First American Corelogic and LoanPerformance databases.

Alt-A

Subprime ARM Defaults Are 12 Times Those for Prime

Delinquent or In Foreclosure (Percent of Number)

Prime, 2.08

Subprime ARM, 26.09

Subprime FRM, 9.82

FHA & VA, 5.96

0

5

10

15

20

25

30

Q2 19

98

Q4 19

98

Q2 19

99

Q4 19

99

Q2 20

00

Q4 20

00

Q2 20

01

Q4 20

01

Q2 20

02

Q4 20

02

Q2 20

03

Q4 20

03

Q2 20

04

Q4 20

04

Q2 20

05

Q4 20

05

Q2 20

06

Q4 20

06

Q2 20

07

Q4 20

07

Subprime Loans Accounted for Over Half of Foreclosures Since 2006

Source: Mortgage Bankers Association National Delinquency Survey(data as of December 2007, number expanded to reflect 85% coverage).

Number of foreclosures started (Annualized rate in thousands)

0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA

Prime (includes Alt-A)

37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%

33%

52%

17%

31%

55%

13%

32%

54%

9%

37%

Subprime: 13% of loans serviced (December)


0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA


37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%

33%

52%

17%

31%

55%

13%

32%

54%

9%

37%



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA


37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%

33%

52%

17%

31%

55%

13%

32%

54%

9%

37%



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA


37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%

33%

52%

17%

31%

55%

13%

32%

54%

9%

37%



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA


37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%


0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA



0

300

600

900

1,200

1,500

1,800

2003H2

2004H1

2004H2

2005H1

2005H2

2006H1

2006H2

2007H1

2007H2

Subprime

FHA and VA


37%

29%

34%

37%

29%

34%

36%

29%

35%

44%

22%

34%

47%

20%

33%

56%

11%

33%

52%

17%

31%

55%

13%

32%

54%

9%

37%


Less than 60% 60%-110%110%-180%More than 180%

Percent Change in Delinquency Rate of Subprime ARM Loans Between 2005Q2 and 2007Q2

Sources: Mortgage Bankers Association, Milken Institute.

National Subprime Foreclosure Ratesby Origination Year*

1999 2000 2001 2002 2003 2004 2005 2006Year to

July 2007

Originate year 1.30 1.50 1.85 1.07 0.82 0.86 0.97 2.56 3.011st year 6.33 6.86 7.17 5.51 4.14 3.93 6.38 7.692nd year 5.46 6.01 5.81 4.55 3.11 3.66 4.663rd year 4.85 3.35 4.23 2.37 2.23 1.854th year 2.29 2.49 1.88 1.56 0.835th year 2.05 1.19 1.17 0.596th year 0.79 0.71 0.487th year 0.56 0.308th year 0.24

188,026 165,801 140,195 124,781 127,100 176,729 231,360 140,278 13,272

787,420 739,749 620,945 797,625 1,143,037 1,716,141 1,925,780 1,368,706 440,934

23.88 22.41 22.58 15.64 11.12 10.30 12.01 10.25 3.01

Total Number of Foreclosures From

Origination through September 2007

Total Number of Originations

Foreclosure Rate through September 2007

*Foreclosure rates are based on the number of loans starting foreclosure.

Foreclosure Rates in Origination Year and

Subsequent Years

Origination Year

For

eclo

sure

Yea

r

California Subprime Foreclosure Ratesby Origination Year*

1999 2000 2001 2002 2003 2004 2005 2006Year to

July 2007

Originate year 0.88 0.76 1.01 0.70 0.48 0.50 0.76 5.20 4.881st year 4.03 3.72 4.29 3.18 2.08 2.04 5.97 14.102nd year 3.01 2.99 2.74 1.68 0.79 1.46 5.513rd year 2.66 1.26 1.17 0.36 0.34 0.854th year 0.93 0.49 0.22 0.16 0.125th year 0.46 0.11 0.12 0.066th year 0.12 0.07 0.047th year 0.06 0.028th year 0.03

9,160 8,389 9,528 9,137 8,944 16,161 39,198 31,295 2,973

75,224 88,915 99,412 148,796 235,065 333,327 320,200 162,134 60,871

12.18 9.43 9.58 6.14 3.80 4.85 12.24 19.30 4.88

Total Number of Foreclosures From

Origination through September 2007

Total Number of Originations

Foreclosure Rate through September 2007

*Foreclosure rates are based on the number of loans starting foreclosure.

Foreclosure Rates in Origination Year and

Subsequent Years

Origination Year

For

eclo

sure

Yea

r

Determinants of Delinquency andForeclosure Rates in CBSAs

January 1999–December 2006

VariablesC -16.868*** -8.036*** -7.780*** -3.035*** -10.365*** -6.498***ARM 21.771*** 22.567*** 11.523*** 12.191*** 10.089*** 10.202***FICO < 620 9.757*** 1.563* 3.266*** -1.068** 7.767*** 4.017***LTV > 80 53.410*** 33.103*** 27.963*** 17.067*** 24.812*** 15.692***LOWNODOC 17.031*** 20.549*** 7.628*** 10.058*** 9.867*** 11.075***Interaction of All Four Loan Characteristics

201.692*** 164.110*** 118.785*** 89.430*** 73.308*** 62.224***

Population 1.688*** 0.823** 0.949***Median Family Income Growth -2.048*** -0.768** -1.719***Home Price Growth -25.700*** -13.091*** -11.435***Unemployment 1.340*** 0.719*** 0.613***Average Loan Size -0.049*** -0.028*** -0.021***

Adjusted R-square 0.6466 0.7043 0.6200 0.6768 0.6395 0.6962Number of Observations 34224 34224 34224 34224 34224 34224Number of CBSAs 360 360 360 360 360 360

60+ Days Delinquent and In Foreclosure

90+ Days Delinquent and In Foreclosure In Foreclosure

Note: ***, **, and * denote significance at 1, 5, and 10 percent levels, respectively. CBSA denotes core-based statistical area. Includes CBSA fixed effects.



VariablesC -20.594*** -14.972*** -10.032*** -7.082*** -11.168*** -8.664***ARM 23.762*** 24.692*** 12.482*** 13.304*** 11.056*** 11.228***FICO < 620 10.678*** 5.818*** 4.407*** 1.788*** 6.731*** 4.553***LTV > 80 60.163*** 41.033*** 31.243*** 20.929*** 27.730*** 19.273***LOWNODOC 12.880*** 20.157*** 6.113*** 10.506*** 7.556*** 10.328***Interaction of All Four Loan Characteristics

307.380*** 187.290*** 166.440*** 92.650*** 128.897*** 84.331***

Population 2.161*** 1.351*** 0.964***Median Family Income Growth -2.213*** -1.101*** -1.320***Home Price Growth -18.750*** -9.630*** -8.970***Unemployment 1.480*** 0.796*** 0.650***Average Loan Size -0.057*** -0.033*** -0.023***







VariablesC -16.427*** -15.111*** -7.510*** -6.824*** -9.204*** -8.671***ARM 26.290*** 27.469*** 13.680*** 14.619*** 12.423*** 12.364***FICO < 620 1.228 0.125 -0.868 -1.482** 2.051*** 1.617***LTV > 80 61.173*** 48.908*** 31.379*** 24.678*** 28.574*** 23.128***LOWNODOC 3.752*** 9.777*** 1.451* 5.173*** 2.487*** 4.438***Interaction of All Four Loan Characteristics

521.907*** 351.432*** 280.018*** 178.666*** 237.738*** 174.602***

Population 2.254** 1.346*** 0.877**Median Family Income Growth -2.403*** -1.251*** -1.402***Home Price Growth -13.716*** -6.812*** -6.535***Unemployment 1.478*** 0.799*** 0.684***Average Loan Size -0.061*** -0.035*** -0.025***





The Mortgage Problem in Perspective

80 million houses25 million are paid off

55 million have mortgages 51 million are paying on-time

4 million are behind

This compares to 50% seriously delinquent in the 1930s

(8% of 55 million with 2% in foreclosure)

Source: U.S. Treasury Department.

“A billion here, a billion there, and A billion here, a billion there, and pretty soon you’re talking real pretty soon you’re talking real

money.”money.”

-- U.S. Senator Everett Dirksen, 1961-- U.S. Senator Everett Dirksen, 1961

““A billion^here, a billion^there, A billion^here, a billion^there, and pretty soon you’re talking real and pretty soon you’re talking real

money.”money.”

-- U.S. Senator Everett Dirksen, -- U.S. Senator Everett Dirksen, 19611961

Estimates of Losses From Subprime Crisis

Date Estimate Source7/19/2007 $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 Wikipedia

3/3/2008 $600 billionGeraud Charpin, head of European credit strategy at UBS in London

3/10/2008 $215 billion Head of Japan's financial regulator

3/13/2008 $285 billion Standard and Poor’s

Supbrime’s Biggest Losers

Source: Bloomberg.

The collapse of credit markets in the United States, driven by the subprime loan crisis, has led to major losses for banks worldwide.

38.237.0

19.516.1

15.414.8

12.69.89.7

9.18.4

7.77.0

42.9CitigroupUBS

Merrill LynchHSBC

IKB Deutsche Royal Bank of Scotland

Bank of AmericaMorgan Stanley

JPMorgan ChaseCredit Suisse

Washington MutualCredit AgricoleDeutsche Bank

Wachovia

Losses/write-downs through May 27, 2008, US$ billions

Recent Losses/Write-downs and Capital Raised by Financial Institutions

Total2Q 2008

(through May 27)

Loss /Write-down

Capital Raised

Loss /Write-down

Capital Raised

Citigroup, United States 42.9 44.1 0.0 12.9

UBS, Switzerland 38.2 28.8 0.0 16.2

Merrill Lynch, United States 37.0 17.9 0.0 4.3

HSBC, United Kingdom 19.5 2.0 0.0 2.0

IKB Deutsche, Germany 16.1 13.3 0.0 0.0

Royal Bank of Scotland, United Kingdom 15.4 23.8 0.0 23.8

Bank of America, United States 14.8 19.7 0.0 6.7

Morgan Stanley, United States 12.6 5.6 0.0 0.0

JPMorgan Stanley, United States 9.8 708.0 0.0 7.8

Credit Suisse, Switzerland 9.7 1.5 0.0 0.0

World total (US$ billions) 382.8 269.9 0.9 139.0

Source: Bloomberg.

Financial Stocks Take Big Hits in Subprime Crisis

-11%

-17%

-18%

-29%

-32%

-40%

-52%

-52%

-53%

-56%

-56%

-63%

-77%

-87%

-94%

-1 -0.8 -0.6 -0.4 -0.2 0

JP Morgan & Chase

Goldman Sachs

Wells Fargo

Bank of America

Morgan Stanley

AIG

Lehman Brothers

UBS

Wachovia

Fannie Mae

Merrill Lynch

Freddie Mac

Washington Mutual

Countrywide

Bear Stearns

Source: Bloomberg.

Percentage change in price, December 2006–March 2008

Leverage Ratios of Different Types of Financial Firms 2007

9.8

8.4

8.4

31.6

24.7

0 5 10 15 20 25 30 35

Commerical banks

Savings institutions

Credit unions

Brokers and hedge funds

Government-sponsored enterprises

Asset/CapitalSource: David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin, 2008

Too Much Dependence on Debt? Leverage Ratios At Biggest Investment Banks

Note: * the latest figure is as of December 2007Sources: Bloomberg.

15

20

25

30

35

40

BearStearns

MorganStanley

MerrillLynch

LehmanBros.*

GoldmanSachs

Total assets to total shareholder equity

March 2001

March 2008

15

20

25

30

35

40

BearStearns

MorganStanley

MerrillLynch

LehmanBros.*

GoldmanSachs


15

20

25

30

35

40

BearStearns

MorganStanley

MerrillLynch

LehmanBros.*

GoldmanSachs


March 2001

March 2008

5

9

13

17

21

Citigroup JP Morgan Chase Bank of America


Banks Depend Less on Debt Leverage Ratios At Bank Holding Companies

March 2001

March 2008

Sources: Bloomberg.

December 2007

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.

Source: Moody’s Source: Moody’s

Downgrades in the Asset-Backed Securities Markets

0 1 15

0 13

12 30

123 1 0 4 140

80 171

122 539

1,635

1,215

210

415

6,566

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

0 1 0 0

6 6

23

0 0 0 0 0 0

15

7 9

78

134

92

8 5

85

0

20

40

60

80

100

120

140

160

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

AAA DowngradesIn the Asset-Backed Securities Markets

Source: Moody’s Source: Moody’s

Downgrades in the Asset-Backed Securities Markets

0 1 15

0 13

12 30

123 1 0 4 140

80 171

122 539

1,635

1,215

210

415

6,566

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

0 1 0 0

6 6

23

0 0 0 0 0 0

15

7 9

78

134

92

8 5

85

0

20

40

60

80

100

120

140

160

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

AAA DowngradesIn the Asset-Backed Securities Markets

Most New Securities Were Rated AAAby S&P in 2007

200

400

600

800

1,000

1,200

1,400A

AA

AA A

A+

AA

-

BB

B A-

BB

B

AA

+ B

A1+ B

-

B+

CC

C

BB

-

BB

+ B

BB

CC

C C

Number

1,295 or 45% of new securities rated

by S&P were rated AAA in 2007

When is a AAA not a AAA? Multilayered structured credit products

AAA 80%

AA 11%

A 4%

BBB 3%

BB-unrated 2%

Senior AAA 88%

Junior AAA 5%

AA 3%

A 2%

BBB 1%

Unrated 1%Mortgage bonds

Mortgage loans

High-grade structured-finance CDO

Senior AAA 62%

Junior AAA 14%

AA 8%

A 6%

BBB 6%

Unrated 4%

Senior AAA 60%

Junior AAA 27%

AA 4%

A 3%

BBB 3%

Unrated 2%

Mezzanine structured-finance CDO

CDO-Squared

Source: International Monetary Fund.

Most Texas Banks Were AAA in the 1980s

First RepublicBank Corporation

Foreclosures in Houston

30,000

1,000

10,000

20,000

1980 1986 1992

Source: Harris County Foreclosure Listing Service.

Widening Spreads Mortgage-backed and High-yield Bonds

Source: Bloomberg.

ML High-Yield Bond Index

ML BBB Mortgage-Backed Securities Index

0

200

400

600

800

1000

1200

Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08

Basis point spread above 10-year treasury bond

ML High-Yield Bond Index

ML BBB Mortgage-Backed Securities Index

0

200

400

600

800

1000

1200


Basis point spread above 10-year treasury bond

Widening Spreads Municipal Bonds

Source: Bloomberg.

ML municipal master index yield spread

-80

-40

0

40

80

120


Basis point spread over 10-year treasury bond

ML municipal master index yield spread

-80

-40

0

40

80

120


Basis point spread over 10-year treasury bond

Market for Liquidity Freezes

Thirty-Day AA Rated Commercial Paper Rates

Nonfinancial Commercial

Paper

Financial Commercial

Paper

Asset-backed Commercial

Paper

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

May07

Jun07

Jul07

Aug07

Sep07

Oct07

Nov07

Dec07

Jan08

Feb08

Mar08

Apr08

May08

Percent


Mortgage Loan Fraud Surges

Source: Financial Crimes Enforcement Network.

0

10

20

30

40

50

60

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Thousands

293225

429

1,014

813

946

0

200

400

600

800

1,000

1,200

2002 2003 2004 2005 2006 2007

US$ Millions

Dollar Losses in Reported Cases of Mortgage Fraud

Source: Federal Bureau of Investigation.

The end of S&L crisis

LTCM Dotcom

Subprime

-40

-20

0

20

40

60

80

100

Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08

Percent

The end of S&L crisis

LTCM Dotcom

Subprime

-40

-20

0

20

40

60

80

100


Percent

-40

-20

0

20

40

60

80

100


Percent

Tightened Standards For Real Estate Loans

Net percentage of domestic respondents tightening standards for commercial real estate loans


Despite Federal Funds Rate Cuts, Mortgage Rates Remain Relatively Flat

Sources: Federal Reserve, Freddie Mac.

Freddie Mac 30-year fixed mortgage rate

Federal funds rate

Spread

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

January 2007 June 2007 November 2007 April 2008

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Freddie Mac 30-year fixed mortgage rate

Federal funds rate

Spread

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

January 2007 June 2007 November 2007 April 2008

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

Percentage of people in a study who could not correctly identify various loan terms using current mortgage disclosure forms

Is Adequate Information Disclosed to Consumers?

Source: Los Angeles Times, June 14, 2007. Percent

Loan amount: 51

Monthly payment: 21

Total upfrontCost: 87

Existence of prepayment

penalty: 68

Annual percentage rate: 20

0 20 40 60 80 100

Loan amount: 51

Monthly payment: 21

Total upfrontCost: 87

Existence of prepayment

penalty: 68

Annual percentage rate: 20

0 20 40 60 80 100

Does this feel like the bottom of a downturn?

Yes: 27%

No: 73%

Looking For a Bottom

Source: The Wall Street Journal, April 11, 2008.

Economists say the economy isn’t at its low point yet, and house prices likely won’t get there until 2009

When will home prices hit bottom?

4%

17%

38%

29%

6%

1st half

2008

2nd half

2008

1st half

2009

2nd half

2009

1st half

2010

Annual rents as % of house prices

Source: :”The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing,” December 2007.

How Far Do Home Prices Have to Fall?

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

1960

Q1

1962

Q3

1965

Q1

1967

Q3

1970

Q1

1972

Q3

1975

Q1

1977

Q3

1980

Q1

1982

Q3

1985

Q1

1987

Q3

1990

Q1

1992

Q3

1995

Q1

1997

Q3

2000

Q1

2002

Q3

2005

Q1

2007

Q3

2010

Q1

History of Credit Disruptions: 1998–Today

Nov - Aug 1998

4Q 2001 - 2002 Jul 2007- Present

Key Causes

Russian credit default

Long Term Capital

Weak credit fundamentals

Major corporate defaults and accounting scandals

(Enron, WorldCom)

Deteriorating housing/subprime market

Market de-leveraging

Investment Grade Spread Widening

70+ bps 80+ bps 1200+ bps

Key Issues

Significant counterparty risk

Corporate scandals and fraud

Tremendous supply/demand imbalance

Recapitalization of financial institutions

Recent credit disruption was preceded by 5 years of benign credit market

What Went Wrong:

1960s

1980s

Today

2020s?

Nonresident speculators

Regulators/central bankers

Brokers/other intermediaries

Rating agencies

Institutional investors

Home buyers

Appraisers

Enough Blame to Go Around

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

$1 Trillion Losses

Ratings consistency

Real estate price fluctuation

Interest rate volatility

Sovereign debt risk

Leverage

Business volatility

Liquidity risk

Counterparty risk

Currency risk

Unexpected regulatory requirements

Complexity

Credit Issues

1974:

The most important year

in financial history

since World War II.

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:

1974:

RESULT

Companies with the highest returns on Companies with the highest returns on

capital, fastest rates of market share capital, fastest rates of market share

and employment growth, greatest and employment growth, greatest

contributions to technological and contributions to technological and

new- product innovation were denied new- product innovation were denied

access to equity and debt capital.access to equity and debt capital.

For 1975 through 1976, the return on For 1975 through 1976, the return on

investment non-investment debt-grade investment non-investment debt-grade

portfolios to investors was 100% portfolios to investors was 100%

unleveraged. unleveraged.

Fewer than 1 percent of those companies Fewer than 1 percent of those companies

projected to be candidates for projected to be candidates for

bankruptcies actually defaulted.bankruptcies actually defaulted.

“I’ll Never Own a Stock Again”Dow Jones Industrial Average

1052 on 11 Jan. 1973

578 on 6 Dec. 1974

Index

1973 1974 1975 1976500

600

700

800

900

1,000

1,100

The $55 Billion MisunderstandingInvesting 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%.

Avon ADP Coke Disney

Dr. Pepper Kodak H-P J&J

Eli Lilly Marriott McDonald’s Merck

Polaroid Rite-Aid Wal-Mart Xerox

Avon ADP Coke Disney

Dr. Pepper Kodak H-P J&J

Eli Lilly Marriott McDonald’s Merck

Polaroid Rite-Aid Wal-Mart Xerox

The $55 Billion Misunderstanding

Investing in the Nifty Fifty12/31/72 – 12/31/81

The average P/E ratio of these 16 companies dropped from 66 to 11.

Imperial Palace Imperial Palace (Tokyo)(Tokyo)

Residential Property Residential Property (California)(California)

19901990US$5.1 trillionUS$5.1 trillion


Imperial Palace Imperial Palace (Tokyo)(Tokyo)

Residential Property Residential Property (California)(California)



““Real estate pricesReal estate prices

collapsed, creditcollapsed, credit

dried up, housedried up, house

building stopped ...building stopped ...

““Real estate pricesReal estate prices

collapsed, creditcollapsed, credit

dried up, housedried up, house

building stopped ...building stopped ...

in 1792.”in 1792.”

u.s. subprime mortgage market meltdown u.s. subprime mortgage market meltdown james r. barth auburn...

Documents

loans slide

good investment slide

credit boom slide

home prices source

year earlier slide

percent of loan type

existing home sales

home prices dont