U.S.U.S. SubprimeSubprime MortgageMortgage MarketMarket MeltdownMeltdown
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! NOT! Homeownership Rate Reaches Historic High in 2004
69.2% in September 2004 Percent 70
69
68
67
66 67.8% in March 2008 65
64
63
62 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 20052008
Source: U.S. Census Bureau. Home Prices Peak in 2006
Index, January 1987 = 100 600
California median 500 home price
400 S&P/Case-Shiller 300 home price index
200 OFHEO 100 conventional and conforming home price index 0
8 5 6 7 1 2 3 7 8 87 9 0 99 004 19 198 1989 1990 1991 1992 1993 1994 1 19 199 1998 1999 2000 200 200 200 2 2005 2006 200 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/Case- Shiller 10 city 15 S&P/Case- Shiller national 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 200 200
180 180 Great Depression 160 160 World World 1970’s 1980’s War I War II Boom Boom 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 Great World 1970’s 1980’s Current War I Depression War II Boom Boom 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 Existing homes 3.0 (Left axis) 0.5
2.4 0.4
1.8 0.3
1.2 0.2 New homes 0.6 (Right axis) 0.1
0.0 08 0.0 04 06 00 01 02 200720 97 98 99 20 200520 95 96 9 20 20 2003 91 93 9 1 19 20 89 19 1 19 199219 1994 19 199019
Source: U.S. Census Bureau. Single-family Home Sales Reach New High Before Plunging
Millions, SAAR Millions, SAAR 6.5 1.4
6.0 1.2 New homes (Right axis) 5.5 1.0
5.0 0.8
4.5 0.6 Existing homes (Left axis) 4.0 0.4 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: U.S. Census, National Association of Realtors, Moody’s Economy.com. 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 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 4 2 02 0 90 000 200 20062008 8 988 199619982 20 76 1 19 199 1994 198 198219841986 1972197419 197
Source: U.S. Census Bureau. Homes Sit Longer on the Market
Millions Months 4.0 11
10 3.5 9 3.0 Homes available 8 for sale 2.5 (Left axis) 7 6 2.0 5 Months supply 1.5 (Right axis) 4 1.0 3 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Sources: National Association of Realtors, Moody’s Economy.com. Home Prices and Credit Boom
Index, January 2000 = 100 250 US$ billions Total 4,500 originations 200 (R) 4,000 3,500 S&P/Case- 150 Shiller® 3,000 home price 2,500 100 index (L) Subprime 2,000 originations 1,500 50 (R) 1,000 500 0 0 06 07 0 1 05 0 0 0 0 0 2 2 4 5 0 0 2003 2004 2 9 9 2 2 2002 1997 1998 1999 19 19 1996 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
10 Share of all loans 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 21.4 21.3 21.1 20.6 20.9 20.9 20.9 20.8 21 20.2 20.2 19.0 19 17.9 16.9 17 15.8 14.8 15 14.4
13 11.7 12.0 11.9
11
7 7 7 9 6 6 6 5 5 200 4 006 3 4 2 200 3 004 Q3 Q4 200 2 Q4 200Q1 2007Q2 200 200 Q1 Q2 200Q3 Q2 200Q3 2005Q4 200 Q3 Q4 200Q1 2005 Q4 200Q1 2004Q2 Q1 2003Q2 200Q3 2003
Source: Mortgage Bankers Association. ARM Mortgage Share by Loan Type
Percent of loan type
70 FHA Prime 60 Subprime
50
40
30
20
10
7 7 6 6 7 0 0 5 0 0 0 5 0 0 0 2 4 4 006 2 2 3 0 0 2 200 3 0 0 005 200 2 1 Q3 200Q4 0 004 200 2 2 1 Q4 Q Q2 2007 003 2 2 1 Q Q2 2006Q3 2 200 Q2 2005Q3 Q4 1 Q3 Q4 Q 1 Q4 Q Q2 2004 Q Q2 2003Q3
Source: Mortgage Bankers Association. Prime and Subprime Home Mortgage Originations
Share of Total (%) Total Originations Year (US$ Trillions) Prime Subprime Originations Originations 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.
4.6% 14.4% 2.6% 8.0% 14.4% 2.7% 4.9% 33.2% 8.4% 13.4% 11.3% 47.3% 56.9% 19.4% 7.9%
20.1% 16.1% 14.3%
2007 2001 2006 $2.4 trillion $2.2 trillion $3.0 trillion
Conventional, conforming prime Jumbo prime
Subprime Alt-A
Source: Inside Mortgage Finance. FHA & VA Home equity loans 2/28 ARMs Dominate Subprime Home-purchase Loan Originations in 2006
Other OtherOther ARM ARM Fixed 4% 7% 9% Other ARM ARM 30Yr ARM 2-year 23% ARM Hybrids Balloon W/ 23% & 3-year hybrids 40-50-Yr Fixed hybrids Fixed 46% Amtz 26% 70% 61% 31%
Prime Subprime Alt-A conventional
Source: Freddie Mac. Subprime Mortgage Loans Outstanding
US$ billions 1,400 1,200 1,240 1,200 973 940 1,000 895 800 699 574 600 416 479 319 344 382 400 290 283 200 0 6 7 Q 05 1 0 01 03 0 200 6 99 0 0 2004 2 200 08 95 97 9 2 2002 2 0 9 9 1998 1 200 2 1 199 1
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%
99 39 99 39 79 39 79 00 479 4 519 5 559 579 5 619 6 659 6 699 719 7 759 7 799 9 ------0 - 459 80 20 80 20 60 460 4 500 5 540 560 5 600 6 640 6 680 700 720 - 740 760 - 780 800 -
FICO Score National Distribution of FICO Scores
Percentage of Population 30 27
25
20 18 15 15 13 12
10 8 5 5 2
0 up to 500-549 550-599 600-649 650-699 700-479 750-799 800 499 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 Other 10.0 Student Loans 9.0 8.0 Home Equity 7.0 6.0 Credit Card
5.0 Automobile 4.0 3.0 Non-agency MBS 2.0 Agency CMO 1.0 0.0 Agency MBS 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 2007, Total = US$9,682 Billions
Student Loans 1% Student Loans Other Home Equity Other 3% 11% 3% 8% Home Equity Credit Card 6% 6% Credit Card Automobile 4% 3% Agency MBS Automobile 46% Non-agency Agency MBS 2% MBS 54% 9% Non-agency MBS 14% Agency CMO 16% Agency CMO 14%
Source: Securities Industry and Financial Markets Association. Home Mortgage Security Issuance
1985, Total = $110 Billion 2006, Total = $2.1 Trillion 2007, Total = $1.9 Trillion
Non- Agency 2% GNMA GNMA FNMA 4% 5% 21% FHLMC 18% GNMA Non- FHLMC 42% Agency 24% 38% Non- Agency 56% FNMA 22%
FHLMC FNMA 35% 33% Outstanding Home Mortgage Securities
1986, Total = $548 Billion 2006, Total = $5.7 Trillion 2007, Total = $6.6 Trillion
Non- Agency MBS Ginnie Ginnie Fannie 3% Mae MBS Mae MBS Mae MBS Non- 7% Non- 7% 18% Agency Agency MBS Freddie MBS Freddie Ginnie32% Mac PCs 32% Mac PCs Mae MBS 26% 26% 48%
Freddie Fannie Fannie Mac PCs Mae MBS Mae MBS 31% 35% 35% Private-label Mortgage-backed Security Issuance Has Fallen Sharply
Dollar amount of Issuance, US$ billions Subprime & other 200 Alt-A
52 30 Prime Jumbo 150 Freddie Mac & 37 16 Fannie Mae 34 8 20 14 7 100 19
50 99 101 85 94 97
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 2006 Number of mortgage brokers: Number of mortgage brokers: 7,000 Brokers 53,000 20%
Others 42% Brokers 58%
Others80%
Source: Wholesale Access. 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%
General Mortgage-Backed Obligation Securities: U.S. 34% 15% 19% 45% Utility Other Asset- Revenue Backed Securities: Tax-Backed U.S. 15%Revenue 11% Mortgage-Backed 28% 8% Transportation Securities: Revenue 19% 6% International Other Asset- Other Backed Securities: International Other Securitization: Originate to Distribute vs. Originate to Hold
100% Other Non-Agency 80% Issuers 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 Oct. 07: Merrill announces Apr. 07: New Century, $7.9b in subprime write- 1,600 a mortgage broker, Aug. 07: Fed cuts downs, surpassing Citi’s files for bankruptcy discount rate to $6.5 billion 5.75% 1,550 Mar. 11, 08: Fed offers Dec. 06: Ownit troubled banks as Mortgage, a subprime much as $200 billion 1,500 lender, files for bankruptcy Mar. 16, 08: JP 1,450 Morgan offers to buy Bear Stearns 1,400 Jul. 07: Two Bear Jan. 11, 08: BofA agrees Stearns hedge funds to buy Countrywide Feb. 07: HSBC says it file for bankruptcy 1,350 set aside $10.6 billion Jan. 30, 08: Fed for bad loans, incl. cuts discount subprime rate to 3.5% 1,300 Mar. 18, 08: Fed cuts discount rate to 2.4%; Fed funds rate to 2.25% 1,250 2006 Q4 2007 Q1 2007 Q22007 Q3 2007 Q4 2008 Q1
Sources: BusinessWeek (March 31, 2008), Standard & Poor’s and Global Insight. 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-AAlt A
5% Jumbo prime
0% 6 0 4 -06 - -07 2 -0 -05 ul-07 0 -04 ul-05 n an J 0 -02 - -03 n an Jul J 0 -01 ul-03 Jul J Ja -00 - n J Ja J n ul-01 Jul Jan Jul J Ja Ja Jan
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
FHA & VA, 5.96 5
Prime, 2.08 0
9 9 1 1 3 3 5 5 7 7 98 00 02 04 9 99 0 00 0 00 0 00 00 1998 1 1 2000 2 2 2002 2 2 2004 2 2 2006 2006 2 Q2 Q4 Q2 Q4 199Q2 Q4 Q2 Q4 200Q2 Q4 Q2 Q4 200Q2 Q4 Q2 Q4 200Q2 Q4 Q2 Q4 200 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 54% 1,200 Prime (includes Alt-A)
900 56% 55% 9% 600 37% 36% 37% 44% 47% 52% 11% 13% 29% 29% 29% 22% 20% 37% 300 17% 33% 32% 34% 35% 34% 34% 33% 31% 0 2003 2004 2004 2005 2005 2006 2006 2007 2007 H2 H1 H2 H1 H2 H1 H2 H1 H2 Source: Mortgage Bankers Association National Delinquency Survey (data as of December 2007, number expanded to reflect 85% coverage). 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*
Origination Year Foreclosure Rates in Origination Year and Year to 1999 2000 2001 2002 2003 2004 2005 2006 Subsequent Years July 2007 Originate year 1.30 1.50 1.85 1.07 0.82 0.86 0.97 2.56 3.01 1st year 6.33 6.86 7.17 5.51 4.14 3.93 6.38 7.69 2nd year 5.46 6.01 5.81 4.55 3.11 3.66 4.66 3rd year 4.85 3.35 4.23 2.37 2.23 1.85 4th year 2.29 2.49 1.88 1.56 0.83 5th year 2.05 1.19 1.17 0.59 6th year 0.79 0.71 0.48
Foreclosure Year Foreclosure 7th year 0.56 0.30 8th year 0.24 Total Number of Foreclosures From 188,026 165,801 140,195 124,781 127,100 176,729 231,360 140,278 13,272 Origination through September 2007 Total Number of 787,420 739,749 620,945 797,625 1,143,037 1,716,141 1,925,780 1,368,706 440,934 Originations
Foreclosure Rate through 23.88 22.41 22.58 15.64 11.12 10.30 12.01 10.25 3.01 September 2007
*Foreclosure rates are based on the number of loans starting foreclosure. California Subprime Foreclosure Rates by Origination Year*
Origination Year Foreclosure Rates in Origination Year and Year to 19992000200120022003200420052006 Subsequent Years July 2007 Originate year0.880.761.010.700.480.500.765.204.88 1st year4.033.724.293.182.082.045.9714.10 2nd year3.012.992.741.680.791.465.51 3rd year2.661.261.170.360.340.85 4th year0.930.490.220.160.12 5th year0.460.110.120.06 6th year0.120.070.04
Foreclosure Year Foreclosure 7th year 0.06 0.02 8th year 0.03 Total Number of Foreclosures From 9,160 8,389 9,528 9,137 8,944 16,161 39,198 31,295 2,973 Origination through September 2007 Total Number of 75,224 88,915 99,412 148,796 235,065 333,327 320,200 162,134 60,871 Originations Foreclosure Rate through 12.18 9.43 9.58 6.14 3.80 4.85 12.24 19.30 4.88 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
60+ Days Delinquent 90+ Days Delinquent Variables and In Foreclosure and In Foreclosure In Foreclosure C -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 201.692*** 164.110*** 118.785*** 89.430*** 73.308*** 62.224*** Characteristics
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 0.6962 Number of Observations 34224 34224 34224 34224 34224 34224 Number of CBSAs 360 360 360 360 360 360 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 2005
60+ Days Delinquent 90+ Days Delinquent Variables and In Foreclosure and In Foreclosure In Foreclosure C -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 307.380*** 187.290*** 166.440*** 92.650*** 128.897*** 84.331*** Characteristics
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***
Adjusted R-square 0.6396 0.6927 0.6085 0.6626 0.6355 0.6852 Number of Observations 30036 30036 30036 30036 30036 30036 Number of CBSAs 360 360 360 360 360 360 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
60+ Days Delinquent 90+ Days Delinquent Variables and In Foreclosure and In Foreclosure In Foreclosure C -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 521.907*** 351.432*** 280.018*** 178.666*** 237.738*** 174.602*** Characteristics
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***
Adjusted R-square 0.6329 0.6746 0.5987 0.6417 0.6328 0.6730 Number of Observations 25848 25848 25848 25848 25848 25848 Number of CBSAs 360 360 360 360 360 360 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. “AA billionbillion here,here, aa billionbillion there,there, andand prettypretty soonsoon youyou’’rere talkingtalking realreal money.money.””
---- U.S.U.S. SenatorSenator EverettEverett DirksenDirksen,, 19611961 ““AA billion^herebillion^here,, aa billion^therebillion^there,, andand prettypretty soonsoon youyou’’rere talkingtalking realreal money.money.””
---- U.S.U.S. SenatorSenator EverettEverett DirksenDirksen,, 19611961 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 Wikipedia Geraud Charpin, head of European 3/3/2008 $600 billion credit strategy at UBS in London 3/10/2008 $215 billion Head of Japan's financial regulator 3/13/2008 $285 billion Standard and Poor’s Supbrime’s Biggest Losers
Losses/write-downs through May 27, 2008, US$ billions Citigroup 42.9 UBS 38.2 Merrill Lynch 37.0 HSBC 19.5 IKB Deutsche 16.1 Royal Bank of Scotland 15.4 Bank of America 14.8 Morgan Stanley 12.6 JPMorgan Chase 9.8 Credit Suisse 9.7 9.1 Washington Mutual The collapse of credit markets in Credit Agricole 8.4 the United States, driven by the Deutsche Bank 7.7 subprime loan crisis, has led to Wachovia 7.0 major losses for banks worldwide. Source: Bloomberg. Recent Losses/Write-downs and Capital Raised by Financial Institutions
2Q 2008 Total (through May 27) Loss Loss Capital Capital /Write- /Write- Raised Raised down down 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
Percentage change in price, December 2006–March 2008
-94% Bear Stearns -87% Countrywide -77% Washington Mutual -63% Freddie Mac -56% Merrill Lynch -56% Fannie Mae -53% Wachovia -52% UBS -52% Lehman Brothers -40% AIG -32% Morgan Stanley -29% Bank of America -18% Wells Fargo -17% Goldman Sachs -11% JP Morgan & Chase
-1 -0.8 -0.6 -0.4 -0.2 0 Source: Bloomberg. 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 5 10 15 20 25 30 35
Source: David Greenlaw, Jan Hatzius, Anil K Kashyap, Hyun Song Shin, 2008 Asset/Capital 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 Morgan Merrill Lehman Goldman Stearns Stanley Lynch Bros.* Sachs Note: * the latest figure is as of December 2007 Sources: Bloomberg. 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 JP Morgan Chase Bank of America Sources: Bloomberg. What Broke the Cycle? z Fraud: by borrowers, brokers, appraisers, lenders. z Cracks in most overheated markets (LA, Las Vegas, Miami) quickly spread everywhere. z Most highly leveraged vehicles (CLOs) collapsed first z Followed by second most leveraged institutions – banks (not hedge funds). z Difference this time: Primary losers are those who own AAA debt.
Downgrades in the Asset-Backed AAA Downgrades Securities Markets In the Asset-Backed Securities Markets 160 7,000 6,566 140 6,000
120 134134 5,000 100 85
4,000 9292 80 7878
3,000 60 1,635 1,635 2,000 40 1,215 1,215 2323 1515 539 539 415 415 99 88 77 66 66 210 210 20 55 171 171 140 140 122 122 80 80 15 30 15 30 11 00 1 1 0 0 13 13 12 12 12 12 3 3 1 1 0 0 4 4 00 00 00 1,000 00 00 00 00 00 00
0 19861986 19871987 19881988 19891989 19901990 19911991 19921992 19931993 19941994 19951995 19961996 19971997 19981998 19991999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 0 1986 1986 1987 1987 1988 1988 1989 1989 1990 1990 1991 1991 1992 1992 1993 1993 1994 1994 1995 1995 1996 1996 1997 1997 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 Source: Moody’s 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
200 C B A B A- B- B+ A+ BB AA AA- BB- A1+ AA+ BB+ CCC BBB BBB CCC AAA When is a AAA not a AAA? Multilayered structured credit products
High-grade structured-finance CDO
Mortgage loans Senior AAA 88% Junior AAA 5% AA 3% A 2% BBB 1% Mortgage bonds Unrated 1% AAA 80% AA 11% Mezzanine structured- CDO-Squared finance CDO A 4% Senior AAA 62% Senior BBB 3% AAA 60% Junior AAA 14% BB-unrated 2% Junior AA 8% AAA 27% A 6% AA 4% BBB 6% A 3% Unrated 4% BBB 3% Source: International Monetary Fund. Unrated 2% Most Texas Banks Were AAA in the 1980s
First RepublicBank Corporation Foreclosures in Houston
30,000
20,000
10,000
1,000
1980 1986 1992
Source: Harris County Foreclosure Listing Service. 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 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08
Source: Bloomberg. 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 6.0 Commercial 5.5 Paper
5.0
4.5 Nonfinancial Commercial 4.0 Paper 3.5 Financial 3.0 Commercial Paper 2.5
2.0
1.5 May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May 07 07 07 07 07 07 07 07 08 08 08 08 08 Source: Federal Reserve. 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 1,014 946 1,000 813 800
600 429 400 293 225 200
0 2002 2003 2004 2005 2006 2007 Source: Federal Bureau of Investigation. Tightened Standards For Real Estate Loans
Net percentage of domestic respondents tightening Percent standards for commercial real estate loans 100 The end of S&L crisis Subprime 80 LTCM Dotcom 60
40
20
0
-20
-40 Mar-90 Mar-93 Mar-96 Mar-99 Mar-02 Mar-05 Mar-08
Source: Federal Reserve. Despite Federal Funds Rate Cuts, Mortgage Rates Remain Relatively Flat
4.0 8.0
Freddie Mac 30-year fixed mortgage rate 3.5 7.0
3.0 6.0
2.5 5.0
Federal funds rate 2.0 4.0
1.5 3.0
1.0 2.0 Spread 0.5 1.0
0.0 0.0 January 2007 June 2007 November 2007 April 2008
Sources: Federal Reserve, Freddie Mac. 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
020406080100
Source: Los Angeles Times, June 14, 2007. 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 When will home prices hit bottom? of a downturn? 1st half 6% 2010 Yes: 27% 2nd half 29% 2009
1st half 38% No: 73% 2009
2nd half 17% 2008
1st half 4% 2008
Source: The Wall Street Journal, April 11, 2008. 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
3.00
3 1 3 Q Q1 Q3 Q Q1 Q Q3 5 2 0 7 6 7 9 0 9 9 9 0 1960 1962Q1 1 1967 Q31970 1Q1 1975 1977Q1 Q31980 1982 Q31985 Q11987 1Q3 1992 1995Q3 Q11997 2000 Q12002 2005Q3 Q12 2010 Q1
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 4Q 2001 - 2002 Jul 2007- Present 1998
zWeak credit zRussian fundamentals zDeteriorating credit zMajor corporate housing/subprime Key Causes default defaults and market zLong Term accounting scandals zMarket de-leveraging Capital (Enron, WorldCom) Investment Grade Spread z70+ bps z 80+ bps z1200+ bps Widening
zTremendous zSignificant supply/demand zCorporate scandals Key Issues counterpart imbalance and fraud y risk zRecapitalization of financial institutions What Went Wrong: 1960s 1980s Today 2020s? Enough Blame to Go Around z Nonresident speculators z Regulators/central bankers z Brokers/other intermediaries z Rating agencies z Institutional investors z Home buyers z Appraisers $1 Trillion Losses
z The “Nifty Fifty” stocks - early 1970s z Sovereign debt: 1980s z Texas banks/Southwest real estate: 1980s z Japanese real estate/equities: 1980s-90s z Technology: 2000 z Housing-related investments: 2007-8 Credit Issues z Ratings consistency z Business volatility
z Liquidity risk z Real estate price
fluctuation z Counterparty risk z Interest rate z Currency risk volatility z Unexpected regulatory requirements z Sovereign debt risk z Complexity z Leverage 1974:
The most important year
in financial history
since World War II. 1974: z Interest rates double in one year; highest level in recent recorded U.S. history z Regulation restricts lending z Energy prices skyrocket z U.S. stock market plunges 50% 1974: RESULT
CompaniesCompanies withwith thethe highesthighest returnsreturns onon capital,capital, fastestfastest ratesrates ofof marketmarket shareshare andand employmentemployment growth,growth, greatestgreatest contributionscontributions toto technologicaltechnological andand newnew-- productproduct innovationinnovation werewere denieddenied accessaccess toto equityequity andand debtdebt capital.capital. ForFor 19751975 throughthrough 1976,1976, thethe returnreturn onon investmentinvestment nonnon--investmentinvestment debtdebt--gradegrade portfoliosportfolios toto investorsinvestors waswas 100%100% unleveragedunleveraged..
FewerFewer thanthan 11 percentpercent ofof thosethose companiescompanies projectedprojected toto bebe candidatescandidates forfor bankruptciesbankruptcies actuallyactually defaulted.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
600 578 on 6 Dec. 1974 500 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
600 578 on 6 Dec. 1974 500 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.
AvonAvon ADP ADP Coke Coke Disney Disney Dr.Dr. PepperPepper Kodak Kodak H-P H-P J&J J&J EliEli LillyLilly Marriott Marriott McDonald’s McDonald’s Merck Merck PolaroidPolaroid Rite-Aid Rite-Aid Wal-Mart Wal-Mart Xerox Xerox ImperialImperial PalacePalace ResidentialResidential PropertyProperty (Tokyo)(Tokyo) (California)(California)
19901990 19901990 US$5.1US$5.1 trilliontrillion US$2.4US$2.4 trilliontrillion ImperialImperial PalacePalace ResidentialResidential PropertyProperty (Tokyo)(Tokyo) (California)(California)
20062006 20062006 US$1.7US$1.7 trilliontrillion US$6.5US$6.5 trilliontrillion ““RealReal estateestate pricesprices collapsed,collapsed, creditcredit drieddried up,up, househouse buildingbuilding stoppedstopped ...... ““RealReal estateestate pricesprices collapsed,collapsed, creditcredit drieddried up,up, househouse buildingbuilding stoppedstopped ...... inin 1792.1792.””