The Way Forward: A Framework for Policy Analysis

Transcription

1 The Way Forward: A Framework for Policy Analysis Subprime Symposium University of Iowa, October 11, 2008 Kathleen E. Keest Senior Policy Counsel

2 Subprime -- risky from the git-go Poor performance rates disguised by rising home values....which kept the exit ramps wide open..especially in bubble regions Origination year % foreclosed or distress prepaid by May, % % % 2

3 Risky borrowers or risky loans? If 1 in 5 Fords collapsed on the road in the first 5 years would you blame the drivers? Or look for a design flaw? Default risk Comes in three flavors: Borrower risks Macroeconomic risks Product & Term risks Compounded the risks by making the risky products the default products in the market. 3

4 Home Values & Foreclosure Risk The Exit Ramp for troubled loans: Refinance or Sale of home, i.e. Distress Prepay Remember Product & Term design aimed at maximizing refinances to keep originations flowing! Leaves options: No equity = No opportunity for distress prepays That s why Iowa & Ohio both had high subprime foreclosure rates early part of decade, despite differing macroeconomic conditions * Loan workouts / forbearance / modification * Foreclosure Ruthless default or Jingle Mail or OOO.. * Out Of Options 4

5 Backdrop: The Two Economies 4 years down the drain (Well, make that 30, really) Average Income Gains Bottom 90% $1000 (3%) Top 1% 75% of all income gains for those 4 years $335,000 (44%) Top.1 of 1% $1.9 million (60%) 5

6 Household Spending: 70% of GDP With stagnating wages or nearly so -- for the bottom 90% for three decades, where s it coming from? Free cash from equity extraction Average $299.6 Billion Average $997.4 Billion Source: Alan Greenspan and James Kennedy, Sources and Uses of Equtiy Extracted from Homes (March, 2007) FRB Working Paper

7 Where s that equity going? Average Average Repaying non-mortgage debt $25.2 Billion $98.9 Billion Home improvement $25.4 Bn $118.4 Bn Personal consumption expenditures $32.5Bn $133.4 Bn Acquisition of assets & other $97.6 Bn $283.6 Bn 7

8 It s the American thing to do And low interest rates have encouraged a housing boom here in America and that s good, that s good. Low interest rates mean that people, for example, have got the capacity to refinance their home.. That s helped our economy.... Low interest rates has helped the American citizens. It s helped them buy a home. It s helped them refinance if they own a home. It s put more money in circulation, which is good for job creation. And home ownership is at nearrecord highs and that s good because we need to be an ownership society in America. Remarks by President Bush on Housing and the Economy, Ruiz Foods, Dinuba, California, October 15,

9 What the.?? The bubble bursts 9

10 Still in the pipeline 10

11 Foreclosures 6.5 Million over next 5 years Estimate: Credit Suisse, Foreclosure Trends: A Sobering Reality April 23,

12 Subprime Foreclosure Impact: US (excludes Alt-A and prime) Subprime Foreclosures expected, Primarily ,164,000 SPILLOVER IMPACT > Surrounding homes suffering price declines caused by nearby subprime foreclosures 40.6 million homes > Decrease in home values $352 billion > Average decrease in home value per unit affected $8,

13 Securitization: WMD?? On the front end of the crisis Driver of the design flaw by perverse incentives that created the problem Fed the housing bubble, fed the debt bubble.. On the back end of the crisis Barrier to finding a circuit breaker necessary to stop the slide. 13

14 Securitization Rates: Subprime / Alt-A % ($ 98.4 B) Rate (MBS Issuance) % ($797.4 B) % ($814.3 B) % ($432.5 B*) (* only $22.5 in 4Q after 8/07 collapse) Source: Inside Mortgage Finance: The 2008 Mortgage Market Statistical Annual: Vol II, p

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16 WAY FORWARD: BASIC LESSONS Economics is not a theology Economics should not be a political ideology Listen to people who are connected to the real world. Trust, but verify E.g.: Subprime increased homeownership rates -- Not 16

17 Way Forward: Arrest the Decline by stopping foreclosures Robert Reich s suggestion Remove hurdles to meaningful mods for Owner- Occupied Bankruptcy Fix (no taxpayer bailout ) Foreclosure moratorium while we figure things out Refinance /HOLC (ditto on moral hazard) Mod hurdles down / REMIC changes/ pay servicers Second liens (Prof. Eggert eminent domain / TARP purchase) 17

18 Origination Reform Reverse perverse incentives in secondary market No YSPs in SP / Alt-A No prepayment penalties Don t pay more for the riskiest product Underwrite (What a concept!) Broker duties Accountability including assignee liability (Dodd vs. Frank bills) Product suitability, design for sustainabiliy not profit maximization 18

19 Regulatory Reform Real regulation & Real outside boundaries. Disclosure value lessens as complexity increases Functional regulation Market Stability regulator (including regulating derivatives sorry, Phil) Safety & soundness regulator (merge OTS into OCC) Consumer Protection Elizabeth Warren s Consumer Financial Products Safety Commission No preemption federal floor, not ceiling 19

20 Economic Fundamentals Pay attention to increasing inequality of incomes The Bottom 90%???? That s not sustainable, either. Pay attention to increasing big-ticket expense demands on shrinking incomes. Don t let public policy response sound like Marie Antoinette: Let them eat debt. 20