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U.S. housing policies are the root cause of the current financial crisis. Other players-greedy investment bankers; foolish investors;
- Peter J. Wallison
Housing price increase during 2000-2005, followed by a levelling off and price decline
Increase in the default and foreclosure rates beginning in the second half of
2006
Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak.
Annual Existing House Price Change
19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08
Source: www.standardpoors.com, S and P Case-Schiller Housing Price Index.
The default rate fluctuated, within a narrow range, around 2 percent prior to 2006. It increased only slightly during the recessions of 1982, 1990, and 2001. The rate began increasing sharply during the second half of 2006 It reached 5.2 percent during the third quarter of 2008.
Default Rate
6% 5% 4% 3% 2% 1% 0%
19 79 19 80 19 81 19 82 19 84 19 85 19 86 19 87 19 89 19 90 19 91 19 92 19 94 19 95 19 96 19 97 19 99 20 00 20 01 20 02 20 04 20 05 20 06 20 07
Source: mbaa.org, National Delinquency Survey.
FORECLOSURE RATE
Housing prices were relatively stable during the 1990s, but they began to rise toward the end of the decade. Between January 2002 and mid-year 2006, housing prices increased by a whopping 87 percent. The boom had turned to a bust, and the housing price declines continued throughout 2007 and 2008. By the third quarter of 2008, housing prices were approximately 25 percent below their 2006 peak.
Foreclosure Rate
1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0%
19 79 19 80 19 81 19 82 19 84 19 85 19 86 19 87 19 89 19 90 19 91 19 92 19 94 19 95 19 96 19 97 19 99 20 00 20 01 20 02 20 04 20 05 20 06 20 07
As of mid-December of 2008, stock returns were down by 37 percent since the beginning of the year. This is nearly twice the magnitude of any year since 1950. This collapse eroded the wealth and endangered the retirement savings of many Americans.
Total Return
60% 50% 40% 30% 20% 10% 0% -10% -20% -30% -40%
19 50
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19 59
19 62
19 65
19 68
19 71
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19 80
19 83
19 86
19 89
19 92
19 95
19 98
20 01
20 04
Source: www.standardpoors.com
20 07
Why did housing prices rise rapidly and then fall? Why did the mortgage default and housing foreclosure rates begin to increase more than a year before the recession of 2008 started?
Why the default and foreclosure rates were so much higher during 20072008?
Why did investment banks like Bear Stearns and Lehman Brothers run
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Subprime mortgages as a share of total mortgages originated during the year, increased from 5% in 1994 to 13% in 2000 and on to 20% in 2004-2006.
School of Business Studies, Sharda University, Greater Noida, U.P, India
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Subprime (FRB)
Subprime (JCHS)
Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University
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1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Subprime (FRB)
Subprime (JCHS)
Subprime + Alt-A
Source: Data from 1994-2003 is from the Federal Reserve Board while 2001-2007 is from the Joint Center for Housing Studies at Harvard University
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The Fed injected additional reserves and kept short-term interest rates at 2% or less throughout 2002-2004. Due to rising inflation in 2005, the Fed pushed interest rates upward. Interest rates on adjustable rate mortgages rose and the default rate began to increase rapidly.
School of Business Studies, Sharda University, Greater Noida, U.P, India
19 95 19 95 19 96 19 96 19 97 19 97 19 98 19 99 19 99 20 00 20 00 20 01 20 02 20 02 20 03 20 03 20 04 20 04 20 05 20 06 20 06 20 07 20 07 20 08
Federal Funds
Source: www.federalreserve.gov and www.economagic.com
1 year T-bill
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20%
15%
10%
5%
0%
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The leverage ratios of loans and other investments to capital assets for various financial institutions are shown here. When Bear Stearns was acquired by JP Morgan Chase its leverage ratio was 33 to 1. Note, this was not particularly unusual for the GSEs and large investment banks.
Leverage Ratios (June 2008)
Freddie Mac Fannie Mae Brokers/hedge Funds Savings institutions Commercial banks Credit unions 0 9.4 9.8 9.1 20 40 60 80 21.5 31.6 67.9
Source: The Rise and Fall of the U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown, Milken Institute
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Between 1950-1980, household debt as a share of disposable (after-tax) income ranged from 40 percent to 60 percent. However, since the early 1980s, the debt-to-income ratio of households has been climbing at an alarming rate. It reached 135 percent in 2007, more than twice the level of the mid-1980s.
Household Debt to Disposable Personal Income Ratio
140% 120% 100% 80% 60% 40% 20%
Source: www.economagic.com
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19 53 19 55 19 58 19 60 19 63 19 65 19 68 19 70 19 73 19 75 19 78 19 80 19 83 19 85 19 88 19 90 19 93 19 95 19 98 20 00 20 03 20 05 20 08
Today, interest payments consume nearly 15 percent of the after-tax income of American households, up from about 10 percent in the early 1980s.
School of Business Studies, Sharda University, Greater Noida, U.P, India
Source: www.economagic.com
19 80 19 81 19 82 19 83 19 85 19 86 19 87 19 88 19 90 19 91 19 92 19 93 19 95 19 96 19 97 19 98 20 00 20 01 20 02 20 03 20 05 20 06 20 07
Total Debt Mortgage
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19 98
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Slide 21 of 31 Source: Liebowitz, Stan J., Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, Ch. 13 in Randall G. Holcombe and Benjamin Powell, eds, Housing America: Building
Fixed Adjustable
Out of a Crisis (New Brunswick, NJ: Transaction Publishers, 2009 (forthcoming) We would like to thank Professor Liebowitz for making this data available to us.
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Slide 22 of 31 Source: Liebowitz, Stan J., Anatomy of a Train Wreck: Causes of the Mortgage Meltdown, Ch. 13 in Randall G. Holcombe and Benjamin Powell, eds, Housing America: Building
Fixed Adjustable
Out of a Crisis (New Brunswick, NJ: Transaction Publishers, 2009 (forthcoming) We would like to thank Professor Liebowitz for making this data available to us.
20 07
Default and foreclosure rates on fixed interest rate mortgages did not rise much in 2007 and 2008. This was true for loans to both prime and subprime borrowers. In contrast, the default and foreclosure rates on adjustable rate mortgages soared during 2007 and 2008 for both prime and sub-prime borrowers.
School of Business Studies, Sharda University, Greater Noida, U.P, India
The combination of lower lending standards, adjustable rate loans, and the Fed's interest rate policies of 2002-2006 was disastrous.
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Are the current conditions unprecedented? How do the current conditions compare with the Great Depression?
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1980-82
1990-91
2007-?
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24%
9%
Source: Bureau of the Census, The Statistical History of the United States from Colonial Times to the Present (New York: Basic Books, 1976)
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Monetary contraction Trade restrictions Tax increases Constant changes in policy; this merely creates uncertainty and delays private sector recovery.
School of Business Studies, Sharda University, Greater Noida, U.P, India
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It will take time for the malinvestments to be corrected and for households to improve their personal financial situation. Various types of stimulus packages are not likely to be very effective.
Danger: Frequent policy changes will retard recovery. The recent policies
School of Business Studies, Sharda University, Greater Noida, U.P, India
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2.
3.
The keys to sound policy are well-defined property rights, monetary and price stability, open markets, low taxes, control of government spending, and above all, neutral treatment of both people and enterprises. Monetary policy is way off track. Since the late 1990s it has been on a stop-and-go course that generates instability. The Fed needs to announce it will follow a stable course in the future. There will be no repeat of the Great Depression, but neither will there be a repeat of the 1970s. President Obama and Congress should announce that: i. The mistakes of the 1930s will not be repeated, including the uncertainty generated by the frequent policy changes that characterized the New Deal. ii. In the future, government spending will be controlled and the deficit reduced.
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Are the current conditions unprecedented? Both the Great Depression and the current crisis are the result of perverse policies.
During the Great Depression era, disastrous policies led to a huge expansion in the size and role of government. Will the same thing
happen this time? The answer to this question will determine the future
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END
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