Restructuring the U.S. Housing Market Franklin Allen, James R. Barth, and Glenn Yago Brookings-Nomura-Wharton Conference on Financial Markets Restructuring Financial Infrastructure to Speed Recovery Friday, October 26, 2012
I. Introduction Housing is one of the most important sectors in the US with residential investment averaging about 5% of GDP and housing services at 12-13% of GDP The recent boom and bust cycle in the US housing market has caused a global financial crisis and the worst US recession since the Great Depression What went wrong and how can the system be fixed? 2
II-III. Early History in the UK and US John Wood and son in Bath, England: model for urban real estate development In the US home ownership accompanied reform and expansion of land ownership for farming By 1890 2/3 of all farm housing was owner occupied 3
Figure 1: U.S. homeownership rate, 1900-2012 Q2 Percent 75 70 65 60 55 50 45 40 4
IV. Development of Modern US Housing Finance First Savings and Loan organized in 1831 and gradually spread around the country Granted tax advantages and developed separately from banking system In the 1930s did not suffer runs because they did not take demand deposits but they did suffer withdrawals to maintain consumption and this caused failures In 1932 Federal Home Loan Bank System set up and in 1934 FSLIC 5
After World War II the Savings and Loan Sector prospered growing from 3% of private financial assets in 1945 to 16% in 1975 As interest rates fluctuated wildly in the late 1970s and early 1990s the Saving and Loan sector was put under severe strain Many failed and regulation was changed so they were able to become much more similar to commercial banks 6
V. Sources of Funding for Home Purchases and Homeownership Rates 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Other Savings institutions and credit unions Commercial Banks Private-label backed mortgage pools Agency- and GSE-backed mortgage pools GSE-home mortgages 7
Figure 2: Sources of funding for home mortgages in selected countries, 2009 Percent 100 90 80 70 60 50 40 30 20 10 0 Deposits Mortgage bonds, including covered bonds Residential mortgage-backed securities Institutional investors Other 8
Figure 3: Covered bonds in selected countries, 2010 US$ Billions Mortgage-backed covered bonds outstanding 500 450 400 350 446 457 300 250 253 269 275 295 200 150 100 94 50 0 0.1 1 5 8 11 13 14 15 27 36 37 39 55 9
Mortgage-backed covered bonds as percent of residential loans outstanding Percent 100 100 80 67 60 44 50 40 31 32 20 0 0.1 0.7 1 2 6 8 12 13 14 19 21 24 25 25 25 10
Figure 4: Homeownership rates in various countries around the world Selected countries, 2009 Percent 100 90 82 82 83 84 89 80 70 60 61 62 64 66 67 67 68 68 71 74 75 77 77 50 40 38 30 20 10 0 11
European Union and other selected countries, 2010 Percent 100 98 90 80 70 66 66 67 69 70 74 75 75 77 77 78 79 80 80 81 81 81 85 85 86 87 87 87 91 93 60 54 56 58 58 59 50 43 40 30 20 10 0 12
Figure 5: Home mortgage debt to GDP in various countries around the world Percent Selected countries, 2009 140 130 120 100 80 71 78 81 60 60 62 40 36 20 0 1 1.7 2.1 2.1 3 5 7 10 15 21 22 13
Percent European Union countries, 2010 110 100 101 107 90 80 82 85 87 70 64 66 69 60 50 40 35 36 41 42 42 44 45 46 47 30 20 12 13 14 17 19 22 23 25 28 10 6 0 14
VI. Federal Government Involvement in Mortgage Markets Since the 1930s the federal government has played an increasingly important role in the allocation of mortgage credit Loan insurance and guarantees: Fannie Mae, Freddie Mac, Ginnie Mae US is one of relatively few countries in which the government provides support to residential mortgage markets 15
Table 2: Government support for mortgage markets Country Government mortgage insurance Government security guarantees Government sponsored enterprises Denmark No No No Germany No No No Ireland No No No Netherlands NHG No No Spain No No No United Kingdom No No No Australia No No No Canada Canada Mortgage Housing Corporation Canada Mortgage Housing Corporation No Japan No Japan Housing Finance Agency Possible South Korea No No Korean Housing Finance Corporation Switzerland No No No United States FHA GNMA Fannie Mae, Freddie Mac, FHLBs 16
Table 3: Housing goals set for Fannie Mae and Freddie Mac 2005-2008 housing goals 1997-2000 housing goals 2001-2004 housing goals 2005 2006 2007 2008 2009 housing goals 2010 redefined benchmarks 2010-2011 housing goals 2012-2014 housing goals Low and moderate income families 42 50 52 53 55 56 43 Low-income families 27 20 Underserved areas 24 31 37 38 38 39 32 Very low-income families 8 7 Special affordable 14 20 22 23 25 27 27 Low-income areas 13 11 Refinancing Mortgages 21 21 17
Figure 6a: Total mortgages outstanding as percentage of GDP Percent 90 80 70 60 50 40 30 20 10 0 18
Figure 6b: Total home mortgages outstanding and share of home financing provided by government-sponsored enterprises US$ trillions Percent 14 60 12 50 10 8 6 4 2 40 30 20 10 0 0 19
Table 4: Date of first mortgage-backed securitization Year Country 1970 United States 1984 Australia and Canada 1985 United Kingdom 1988 France 1989 South Africa 1991 Spain 1995 Germany and Ireland 1996 Argentina 1999 Brazil, Japan, Italy and South Korea 2000 India 2003 Mexico 2004 Malaysia 2005 China 2006 Russia and Saudi Arabia 20
Figure 7: Percentage of bank assets in residential real estate loans (2010) New Zealand Estonia Netherlands South Africa Samoa (Western) Poland Switzerland Latvia Chile United States El Salvador Sierra Leone United Kingdom Belgium Fiji Venezuela Hungary Belarus Cayman Islands Bulgaria Iceland Guyana Serbia Isle of Man Panama Bosnia and Herzegovina Dominican Republic Gibraltar Trinidad and Tobago Uruguay Singapore China Malta Nigeria Burundi Puerto Rico Mauritius Russia Palestinian Territory Jersey Argentina Belize Thailand Swaziland Ghana Jamaica Lesotho Angola 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 21
Figure 8: Percentage of securitized residential real estate loans (2010) Seychelles Puerto Rico Guatemala Netherlands Belgium Colombia Italy Canada United States Greece Mexico Australia Brazil Iceland Malaysia New Zealand Zimbabwe Virgin Islands, British Vanuatu Uruguay Syria Swaziland South Africa Slovenia Singapore Sierra Leone Samoa (Western) Peru Palestinian Territory Namibia Mauritius Malta Lithuania Lesotho Kenya Jersey Jamaica Israel Isle of Man Indonesia India Hungary Honduras Guyana El Salvador Dominican Republic Cyprus Croatia Costa Rica Cook Islands Burundi Botswana Bosnia and Herzegovina Armenia Angola 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 22
VII. Turmoil in global housing markets: Implications for the future of housing finance The residential mortgage market in the United States has worked extremely well over the past two centuries, enabling millions to achieve the dream of homeownership. But there have been periods of turmoil The Great Depression The late 1970s and early 1980s The current period 23
Figure 9: Home prices peak in 2006 and subsequently decline (1991 Q1 2012 Q2; Index, 1991 Q1=100) 350 300 S&P/Case-Schiller Home-Price Index 10-Metro-Composite 250 200 150 100 OFHEO/FHFA Seasonally Adjusted Purchase-Only Index 50 0 24
Housing Problems in Other Countries Table 5: Average house price changes (Rankings of countries in parentheses) Country Boom (1998:Q1-2006-Q2) Bust (2006:Q2-2011:Q3) Overall (1998:Q1-2011:Q3) Similar to the United States? United States 49.9 (15) -22.6 (2) 16.0 (16) - Australia 78.5 (7) 17.7 (17) 110.1 (3) No Belgium 55.2 (11) 12.4 (14) 74.4 (7) No Canada 53.3 (13) 28.5 (19) 96.9 (4) No Denmark 79.5 (6) -19.5 (4) 44.6 (13) Yes Finland 68.4 (8) 2.7 (11) 72.9 (8) No France 102.2 (4) 5.1 (12) 112.6 (2) No Germany -11.4 (18) -5.7 (9) -16.5 (18) No Ireland 131.4 (1) -25.3 (1) 72.9 (9) Yes Italy 53.4 (12) -7.9 (6) 41.2 (14) Yes Japan -25.6 (19) -8.3 (5) -31.8 (19) No Netherlands 61.0 (10) -6.9 (8) 49.8 (12) Yes New Zealand 64.2 (9) -1.7 (10) 61.4 (11) Yes Norway 53.0 (14) 24.3 (18) 90.2 (6) No South Korea 4.4 (17) 6.5 (13) 11.1 (17) No Spain 108.6 (3) -20.8 (3) 65.3 (10) Yes Sweden 83.4 (5) 16.0 (16) 112.9 (1) No Switzerland 10.7 (16) 14.2 (15) 26.4 (15) No United Kingdom 112.2 (2) -7.3 (7) 96.6 (5) Yes 25
Housing Problems in the US versus Canada Figure 10: Homeownership rates in Canada and the US Percent U.S. Canada 70 69 68 67.9 68.8 68.4 69.0 67 66.5 66 65.3 65.4 65.8 65 64 64.3 64.7 63.8 64.1 63.6 63 62 61.8 62.1 62.1 62.6 61 60 60.3 1971 1976 1981 1986 1991 1996 2001 2006 2010 26
Figure 11: Canada and U.S. home prices (yearover-year percentage change) Percent 20 15 10 5 0-5 -10-15 -20 U.S. Canada -25 27
Figure 12: Canada and U.S. residential delinquency rates Percent 6 5 4 U.S. Canada 3 2 1 0 28
Table 6: Key differences in mortgage finance: Canada vs. the United States Country Mortgage interest deduction Main product Recourse Pre-payment penalty Funding model 2006 Peak subprime % outstanding Canada No 5-year FRM Yes Yes On-balance-sheet *Less than 5% U.S. Yes 30-year FRM No No Originate-todistribute 20% 29
VIII. Future Innovations in Housing Finance Diversifying sources of capital (debt and equity) Structuring financial products that will promote private capital investment to support residential real estate construction, maintenance, and sustainable improvement Diversifying types of housing products (single/multiple family) 30
Higher density, sustainable buildings that increase housing consumers cash flow and ability to service long-term debt Pooling savings and risk-management products Credit enhancement Using information technology to monitor and improve efficiency in housing finance 31
Financing Housing: Back to the Future Aligning interests of private capital funders with policy incentives Create a diversified housing stock by eliminating the bias against subsidies for renters Pooling savings to create investment vehicles Using credit enhancement and guarantees to manage real estate risks 32
Creating flexible capital structures for residential developments through structured finance Regulating land use to limit supply constraints. Restoring the role of private investors (domestic and international) as drivers of homeownership and financing. Restoring confidence in securitization through mortgage-backed securities and covered bonds. 33
IX. Lessons Learned Lesson 1: Don t compromise on credit analysis Lesson 2: Flexible capital structure matters Lesson 3: Size matters Lesson 4: Structured products and secondary markets work 34