The Big Picture
Problems in Mortgage Market
Global Credit Crisis / Bank failures / Equity Losses
Declining Consumer Spending Decreased Business Investment
How Financial Markets Enabled“Keeping up with the Joneses”
New Products
Poor Underwriting
Public Policies Unintended Consequences
Low Rates and International Capital Flows
Products
Underwriting
Policy
Markets
Mortgage Market Developments
Securitization and new participantsGraham Leach Bliley Financial Modernization Act of 1999Increased Use of Mortgage Brokers2000 Commodity Futures Modernization Act
Increased Access to CreditSubprime, Alt A, Option ARMs
Products
Underwriting
Policy
Markets
Securitization
Loan Bank B
Financial IntermediaryBuys Loans, Forms a “Pool”
and Issues MBS
Loan Bank A Loan Bank Z
Insurance Firm, Banks, Pension Funds etc.Buy MBS – Cash Flows “Guaranteed” by Original Mortgages
Products
Underwriting
Policy
Markets
Average Size of Subprime Loans
Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, over
50% to total subprime50% to total subprime
Products
Underwriting
Policy
Markets
Credit Quality of Subprime Loans Originated each year
Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans,
over 50% to total subprimeover 50% to total subprime
Products
Underwriting
Policy
Markets
Structure of Subprime Loans Originated each year
Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Demyanyk and Van Hermert, "Understanding the Subprime Mortgage Crisis" Federal Reserve Bank of St. Louis, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans, Working paper 2007-05, August 2008 (sample represents approximately 85% of securitized subprime loans,
over 50% to total subprimeover 50% to total subprime
Products
Underwriting
Policy
Markets
Impact of Subprime Loans on Home Ownership
"SubPrime Lending: A Net Drain on Homeownership," Center for Responsible Lending: March 2007"SubPrime Lending: A Net Drain on Homeownership," Center for Responsible Lending: March 2007
Products
Underwriting
Policy
Markets
NY Times October 4 "Pressured to Take More Risk Fannie Hit a Tipping Point"NY Times October 4 "Pressured to Take More Risk Fannie Hit a Tipping Point"
Fannie Mae’sGuarantee of Alt A Loans
0
50
100
150
200
250
300
$ B
illions o
f Alt
A L
oans G
uara
nte
ed
2005$58
Billion Added
2006$87
BillionAdded
2007$79
BillionAdded
2004 & Before$77 Billion Total
Products
Underwriting
Policy
Markets
Blaming Fannie and Freddie?
No - Fannie and Freddie were small relative to the entire market.
Combined Subprime Purchases (% of Market)**Consumer demand created rapid prince increase
Yes – Overall Size put them at risk for any Mortgage Market problem
Securitizing more risky loans opened door for Private securitization
Gramlich, E. "Subprime Loans: America's Latest Boom an Bust" 2007 ** "how HUD Mortgage Gramlich, E. "Subprime Loans: America's Latest Boom an Bust" 2007 ** "how HUD Mortgage Policy Fed the Crisis", Washington Post June 10, 2008Policy Fed the Crisis", Washington Post June 10, 2008
Products
Underwriting
Policy
Markets
International Capital Flows
Consumer Spending On Exports
Increased Foreign Holdings of $
Increased Inflow of Dollars Helps Keep Long Term Rates Low
Products
Underwriting
Policy
Markets
“The Perfect Storm” 2004 - 2007
Domestic and global institutions buy MBS in attempt to increase margins on “safe” securities, incorrectly rated.
Institutions use higher debt levels for securitization.
Underwriting standards deteriorate.
Increased interest rate environment makes loans more likely to default
Increasing Home Prices encourage consumers to overextend and speculate in housing market
Products
Underwriting
Policy
Markets
Response of Consumers
Increased access to credit and delusional optimism resulted in:
Short-Term Speculative FocusBorrowing More and Saving Less
Case Study: Natalie Brandon
1985 Buys $105,000 house 30 Year fixed rate loan Payment = $770
2000-2006Paid penalties to Refi 5 times in 5 years Yearly income = $100,000 2006 New Loan $625,500 2/28 7.99% teaserPayment = $4,585
Fall 2007Home Value = $450,000Attempt to Refi for 40 years at 6% Fails
Impact of the Crisis
Increase in Precautionary Saving
Lost Wealth from Equity Declines
High Unemployment
Consumer Confidence hits Record Lows
Precautionary Saving
All Silents Boomers Gen X Gen YLess than 2 weeks 28% 11% 25% 31% 32%2 weeks to a month 22% 17% 21% 21% 27%2 to 3 months 22% 23% 24% 19% 22%4 to 6 months 14% 15% 11% 17% 12%7 months to a year 5% 7% 5% 6% 2%More than a year 10% 27% 14% 5% 6%
If you were to lose your job, for how long could you afford to be out of work and still meet your financial obligations including monthly expenses?
The 2009 MetLife Study of the American Dream
Confidence in Having Enough Money to Live Comfortably Throughout Retirement
Years
0
5
10
15
20
25
30
1993 1995 1997 1999 2001 2003 2005 2007 2009
% o
f R
esp
on
den
ts
Very Confident Not at all Confident
“The Pressure I feel to buy more and better material possessions is greater than ever”
Metlife
26%
46%
10%
25%
18%
39%
29%
53%
47%
66%
74%
54%
90%
75%
82%
61%
71%
47%
53%
34%Gen 06
Y 09
Baby 06
Boom 09
All 06
09
Gen 06 X 09
Silent 0609
Agree Disagree
Buyers Remorse
62%
79%
66%
54%
51%
38%
21%
34%
46%
49%
I have no regrets about the major purchases that I have made over the past few years
I regret making major purchases and wish I would have saved more over the past few years
Gen Y
Gen X
Boomers
Silents
All
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