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Comments on “The Origins of the American Mortgage Disaster and Its Lessons for Reform” by Eugene White, FMG-CCSB conference, Feb 29, 2012 John Muellbauer Nuffield College and Institute for New Economic Thinking at the Oxford Martin School Chief culprits • Eugene White’s careful historical comparison of the 1920s housing boom/bust with no banking collapse with that of the 2000s asks: what was similar? what was different? • His answer emphasises 3.5 differences: • Governance of banks • Deposit Insurance/Too Big to Fail • President/Congress Push for Affordable Housing/RE Lobby • Fannie Mae/Freddie Mac Good use of evidence • But suggests that 1920’s building boom partly explained by catch-up after WWI • price ‘bust’ after 1925 was less severe • little sign of immediate contraction in mortgage debt/GDP • Problems postponed to 1930s, and not closely linked to shocks originating in housing or mortgage markets The other factors: how similar is similar? 1. Monetary Expansion: some similarities, as Fed (founded 1913) stabilised interest rates after WWI – but then less far off ‘Taylor rule’ than in 2000s. Mortgage rates were very stable (around 6%), not falling as in 2000s. 2. The ‘Greenspan Put’: in the 1920s, the Fed also wanted to stabilise financial system but 1920s were not stalked by (mistaken) fear of Japan-style lost decade after collapse of a stock market bubble. No risk of weak demand given domestic and global demand for US output after WWI. Other factors… 3. International Imbalances---U.S. net creditor so imbalances had the opposite sign. External investment opportunities kept up real interest rates. Contrasts with currency-manipulating Chinese etc purchases of US govt. bonds, closely linked to US mortgage rates, pressing down mortgage rates. Also European investors, searching for yield in low yield environment were easily conned into buying AAA-rated MBS junk. Other factors… 4. End of Glass-Steagall similar to pre-Glass-Steagall Universal Banking 5. Relaxation of Bank Lending Standards: some similarities e.g. building and loan associations offering piggy-back loans. But all evidence points to far lower LTVs for firsttime buyers in 1920s than 92-3% average reached in 2003-6. 6. Failure of Bank Supervision: some (political influence of bankers then and now?) 7. Securitization/Derivatives: e.g. growth of mortgage bonds; title and mortgage insurance co’s – but scale was much smaller 8. Rating Agencies: Moodys ‘not stringent’ then either. The 3.5 main culprits 9. Greedy/Predatory (Risk-Taking Leveraged) Lenders? partial NO: Double Liability, Better Governance structures suggest less serious problem in 1920s. 10. Greedy/Ignorant (Risk-Taking Leveraged) Borrowers: human nature is ever so 11. NO: Moral Hazard: Deposit Insurance/Too Big to Fail 12. NO: President/Congress Push for Affordable Housing/RE Lobby 13. NO: Fannie Mae/Freddie Mac Omitted factors • Income tax with interest relief started in 1913 – but modest tax rates on all but highest incomes, and top tax rates slashed in 1920s. So tax incentives to get into debt for mass of households were much lower. Hh debt to income ratios were lower, so hhs less vulnerable. • Our research highlights this vulnerability, missed by focus on net worth concept of wealth for understanding consumption. • Unsecured debt was much lower too, before credit card revolution; for a comparison with the 1920s, see Geisst, C. R. 2009. Collateral damaged: The marketing of consumer debt to America. New York, NY: Bloomberg Press. • When did no-recourse mortgages start? Financial accelerator in the 1920s missed the 2nd channel, and 3rd and 4th were much weaker (John Duca graphic) Mortgage and Housing Crisis Lower Demand for Housing Less Home Construction Lower Capital of Financial Firms ↓Home Prices & Wealth, Slower Consumption ↑ Counter-Party Risk, Money & Bond Mkts Hit Slower GDP Growth Credit Standards Tightened on All Loans 3 In the 1920s, the aggregate consumption effect of higher house prices was likely negative Our research (Aron, Janine, John Duca, John Muellbauer, Keiko Murata, and Anthony Murphy (2011), “Credit, Housing Collateral and Consumption: Evidence from the UK, Japan and the US”, online at Review of Income and Wealth. DOI: 10.1111/j.14754991.2011.00466.x) shows housing wealth had zero or negative effect on (conventional national accounts) consumption before credit market liberalisation in US, UK, Australia and South Africa (and remains negative in Japan). With low LTVs in 1920s US, aggregate effect would have been negative as potential first time buyers saved more for a down-payment and as renters could expect to have to pay higher future rents. Hence stabilising macro feedbacks through consumption channel in 1920s. The time varying marginal propensity to consume out of housing wealth in the US 11 Feedbacks via banking, credit market channels now also much larger. Hence I’d put more weight than EW on 5. Relaxation of Bank Lending Standards 6. Failure of Bank Supervision 7. Securitization/Derivatives: remember Ragu Rajan’s prescient Jackson Hole warning in 2005 that these extreme levels of innovation had amplified global financial risk. 8. Rating Agencies. I agree on the importance of his 3.5 main culprits. However, deposit insurance is controversial: would have prevented bank-runs of the 1930s. Did lower levels of deposit insurance in the UK constrain risk-taking by UK banks? I highly recommend EW’s 2010 NBER paper – more subtle than my simplified summary of the issues. Comments on “Achieving Housing Market Equilibrium: Some Policy Options” by David Greenlaw, FMG-CCSB conference, Feb 29, 2012 John Muellbauer, Nuffield College and Institute for New Economic Thinking at the Oxford Martin School Broad agreement with David Greenlaw • DG paints colourful and comprehensive picture of the great US housing and mortgage disaster. • Our own research confirms much of what he says. • But we put more weight on the green shoots given our econometric modelling of the housing market and the interactions with the wider economy. Broader version of the vicious circle Mortgage and Housing Crisis Lower Demand for Housing Less Home Construction Lower Capital of Financial Firms ↓Home Prices & Wealth, Slower Consumption ↑ Counter-Party Risk, Money & Bond Mkts Hit Slower GDP Growth Credit Standards Tightened on All Loans 3 Yes, foreclosures do matter for the wider economy • but bivariate correlations are suspect Yes, economic and credit conditions have been really terrible, but houses are cheap and progress on deleveraging Housing Affordability Index Household Debt Service Percent of Disposable Personal Income 19.0 200 18.5 175 18.0 17.5 150 17.0 125 16.5 100 16.0 75 15.5 15.0 50 82 86 90 94 98 02 06 Source: National Association of Realtors Note: Index = 100 when median family income qualifies for an 80% mortgage on a median priced existing single-family home. Rising index indicates more buyers can afford to enter market. 10 80 84 88 92 96 00 04 Note: Financial obligations series, values for 2011 Q4 to 2012 Q4 represent Morgan Stanley estimates. Source: Federal Reserve Board and Morgan Stanley Research 08 12 Credit conditions easier since 2010 for consumer credit, and starting to ease for prime mortgages Yes, monetary transmission mechanism has been impaired – but far from eliminated • We capture this through the decline in the mpc of housing collateral. • We also model refis and equity withdrawal, with same common latent variable which drives mpc of housing. Yes, economic and credit conditions have been really terrible • But payment delinquencies are down and house prices (excl. distressed) have almost stopped falling 6Mortgage Foreclosures and Delinquencies 20 Percent 15 5 National HPI excluding Distressed 10 Mortgage Payments Past Due 90+ Days 4 5 0 (5) 3 (10) Mortgage Foreclosure Pipeline (EOP) 2 National House Price Index (15) (20) 00 1 01 02 03 05 Source: CoreLogic / Haver Analytics 0 88 90 92 94 96 98 00 02 Source: Mortgage Bankers Association 04 06 08 10 06 07 08 10 11 Green shoots in house prices: dynamic simulation of rent based US hp model • Based on 2-equation model, incl. model for rents. • Rent model suggests rents respond v sluggishly to hp, general price level, and to user cost. • Income-tax credit of 10% of a home’s purchase price up to a cap of $8,000 for couples who were FTBs, expired in June 2010, provided major support in 2009-10. • US house price forecasts made in Dec 2009 by Duca, Murphy and myself correctly foresaw second leg of house price falls after tax credit expiry in June 2010, and predicted bottom in 2012. http://www.aeaweb.org/aea/conference/program/retrieve.p hp?pdfid=446 short form of paper: Duca, J. V., Muellbauer, J. and Murphy, A. (2011), “House Prices and Credit Constraints: Making Sense of the US Experience”. Economic Journal, 121: 533–551. 21 Our new US hp model confirms Dec 2009 simulations* • “Shifting Credit Standards and the Boom and Bust in U.S. House Prices”, Duca, Muellbauer and Murphy • New model (consistent with hp/rent model) is based on inverted demand approach: hp driven by income relative to housing stock, user cost, and LTV for first time buyers. • Model implies over-shooting and shock amplification in booms as user cost uses last 4 years appreciation and enters as a log. Despite low mortgage rate, user cost has just been at 40 year high and is beginning to decline. • Rise and then collapse of LTV was major factor in boom/bust. *Note usual Fed disclaimer, as Duca and Murphy at Dallas Fed LTVs for first-time buyers and all buyers are quite different Our point forecast is for trough in 2012Q3, perhaps earlier for Case-Shiller New paper (24 Feb) “Housing, Monetary Policy, and the Recovery “, Feroli, Harris, Sufi & West • Highlights frictions slowing shift from owner-occ. to rentals and rising rents (welcome reminder that hp is determined not just in owner-occupied market) • Argues that despite 9% vacancy rate in rentals, ‘seismic shift’ of 5-6m additional renters would overwhelm current rental stock. • “nearly 250,000 REOs (‘Real Estate Owned’) held by Fannie, Freddie and the FHA and about 3.0 million additional government mortgages will be liquidated over the next four years”: bulk sales to private investors? DG discusses 3 policy options 1. Streamlined Refi: limited success 2. Rentership: convert owners to renters of existing dwellings – yes! see above. 3. Mortgage Modification (with Shared Appreciation) • The last would be a brilliant option: if done on large scale would give quick help to many and be ultimately very profitable for the government. • US presidential election could be a close call if oil price shock or Eurocrisis derailed US recovery. Otherwise optimistic on prospects both for US economy - and Obama.